Digitconnection.aiAI Course

Chapter 23

Internal and External Balance with Fixed Exchange Rates

Internal and External Balance with Fixed Exchange Rates This chapter presents the analysis of the macroeconomy of a country that has a fixed exchange rate. As noted in the introduction, this analysis is important because some countries currently have fixed exchange rates or floating rates that are so heavily managed that they resemble fixed rates, and because there are ongoing discussions of proposals to return to a system of fixed rates among the world's major currencies.

下载讲义下载 JSON查看实验映射
Slide37
知识点8
案例4
习题60

Knowledge Points

知识点

manual

From the Balance of Payments to the Money Supply

When the country has an official settlements balance surplus, and its central bank intervenes to prevent its currency from appreciating, the central bank must sell domestic currency and buy foreign currency. This increases the central bank's holdings of official reserves and increases its liabilities as the domestic currency is added to the economy.

  • If the country has an official settlement balance surplus, so that the exchange-rate value of the country’s currency is experiencing upward pressure, the central bank must intervene to buy foreign currency and sell domestic currency. This will have the following effects on the central bank’s balance sheet:
  • Official international reserve holdings increase so that R will rise.
  • Liabilities increase, probably an increase in bank deposits at the central bank.
manual

From Money Supply Back to the Balance of Payments

A Tale of Three Countries: (a) If Germany had raised taxes in 1991, then the story probably would have turned out better. If Germany raised taxes, then more of the effort to restrain the excessive growth and overheating of the German economy would have been driven by a shift to the left of Germany’s IS curve (from IS2 back toward IS1), so less of the restraint would have come from the tightening of German monetary policy (Germany’s new LM3 would be to the right of the LM3 shown in the box).

  • If the country begins with a surplus in its overall balance, the surplus requires the central bank to buy foreign currency and sell domestic currency.
  • As the central bank increases the monetary base (bank reserves), it tends to reduce interest rates.
  • The lower interest rates will have several effects on the country’s balance of payments.
manual

Sterilization

Rather than allowing these automatic adjustments toward external balance, the monetary authority can resist by sterilization—taking an offsetting domestic action (like an open market operation) to reduce or eliminate the effect of the intervention on the domestic money supply. This is a wait-and-see strategy. There are limits to how long the country can continue to run an overall payments imbalance.

  • The central bank can keep the external surplus or deficit from having an impact on the domestic money supply by taking offsetting actions.
  • Sterilization
  • is action by the central bank to reverse the effects of official intervention on the domestic money supply.
manual

Monetary Policy with Fixed Exchange Rates

A Tale of Three Countries: (a) If Germany had raised taxes in 1991, then the story probably would have turned out better. If Germany raised taxes, then more of the effort to restrain the excessive growth and overheating of the German economy would have been driven by a shift to the left of Germany’s IS curve (from IS2 back toward IS1), so less of the restraint would have come from the tightening of German monetary policy (Germany’s new LM3 would be to the right of the LM3 shown in the box).

  • Official Intervention
  • Under a fixed exchange-rate regime, the government must defend that rate.
  • The first line of defense is official intervention: The monetary authority (the central bank) buys or sells foreign currency in the foreign exchange market as necessary to keep the exchange rate within the allowable band around the pegged exchange-rate value.
manual

Fiscal Policy with Fixed Exchange Rates

A change in fiscal policy has two opposing effects on the country's overall payments balance. For instance, a shift to expansionary fiscal policy tends to increase both interest rates and real GDP, so the financial account tends to improve while the current account tends to deteriorate. If the former predominates, then the country's overall payments tend to go into surplus.

  • The effectiveness of fiscal policy will depend on the responsiveness of capital flows to the interest rate changes following a fiscal policy.
  • If capital flows are very sensitive to interest rate changes (high capital mobility), then the capital flows will be very large, and the official settlements balance will go into surplus.
  • If capital flows are unresponsive (low capital mobility), then the financial account will only improve a little, and the overall balance will go into deficit.
manual

Perfect Capital Mobility

In the extreme case of perfect capital mobility (with investors expecting the fixed rate to be maintained), monetary policy has no independent effectiveness even in the short run, while fiscal policy has a strong (full spending multiplier) effect on real GDP. The FE curve is a flat line, and the LM curve is effectively this same flat line.

  • A practically unlimited amount of international financial capital flows in response to the slightest change in one country’s interest rates.
  • Perfect capital mobility with fixed exchange rates:
  • Makes it impossible for monetary policy to influence interest rates or the domestic economy.
manual

Shocks to the Economy

We can examine how shocks affect the economy of a country with a fixed exchange rate. A domestic monetary shock has a limited effect. A change in fiscal policy is an example of a domestic spending shock. An international capital flow shock shifts the FE curve. The intervention to defend the fixed exchange rate results in effects on the domestic economy.

  • Internal shocks
  • Domestic monetary shocks
  • Domestic spending shocks
manual

Imbalances and Policy Responses

We can examine how shocks affect the economy of a country with a fixed exchange rate. A domestic monetary shock has a limited effect. A change in fiscal policy is an example of a domestic spending shock. An international capital flow shock shifts the FE curve. The intervention to defend the fixed exchange rate results in effects on the domestic economy.

  • A country wants to achieve both internal balance and external balance. Yet, its actual performance often falls short of these goals.
  • The government of a country in one of the two dilemma cases (deficit and high unemployment, or surplus and rapid inflation) has three basic choices:
  • Abandon the goal of external balance (abandon the fixed exchange rate).

Cases

案例与情境

c.The rightward shift of the IS curve results in a new ...

c.The rightward shift of the IS curve results in a new IS'-LM intersection with some increase in the level of domestic product. The increase in domestic product and income also increases the country's imports. To proceed, let's examine the "normal" case in which the country then has a current account and overall payments surplus, because the increase in exports is larger than the initial increase in imports.

查看原始摘录

c.The rightward shift of the IS curve results in a new IS'-LM intersection with some increase in the level of domestic product. The increase in domestic product and income also increases the country's imports. To proceed, let's examine the "normal" case in which the country then has a current account and overall payments surplus, because the increase in exports is larger than the initial increase in imports. This means that the intersection of the original LM curve and the new IS' curve at E' is to the left of the new FE' curve. If the country's official settlements balance goes into surplus, then the country's central bank must intervene to defend the fixed exchange rate by buying foreign currency and selling domestic currency.

The effect of a large, abrupt change in the exchange rate ...

The effect of a large, abrupt change in the exchange rate on the value of the country's current account (or trade) balance is not so straightforward. The value of the country's current account, measured in foreign currency (superscript fc), is CA = Pfcx X Pfcm M. The effects of a devaluation of the country's currency are: (1) no change or decrease in the foreign currency price of its exports (Pfcx), (2) no change or increase in the volume of exports (X), (3) no change or decrease in the foreign currency price of its imports (Pfcm), and (4) no change or decrease in the volume of imports (M).

查看原始摘录

The effect of a large, abrupt change in the exchange rate on the value of the country's current account (or trade) balance is not so straightforward. The value of the country's current account, measured in foreign currency (superscript fc), is CA = Pfcx X Pfcm M. The effects of a devaluation of the country's currency are: (1) no change or decrease in the foreign currency price of its exports (Pfcx), (2) no change or increase in the volume of exports (X), (3) no change or decrease in the foreign currency price of its imports (Pfcm), and (4) no change or decrease in the volume of imports (M). The response of the trade balance could be unstable (that is, the value of the balance could decline rather that improve) if the decrease in the foreign currency price of exports is large relative to the other changes—an extreme example is perfectly inelastic demands for exports and imports. The respo

A Tale of Three Countries: (a) If Germany had raised taxes ...

A Tale of Three Countries: (a) If Germany had raised taxes in 1991, then the story probably would have turned out better. If Germany raised taxes, then more of the effort to restrain the excessive growth and overheating of the German economy would have been driven by a shift to the left of Germany’s IS curve (from IS2 back toward IS1), so less of the restraint would have come from the tightening of German monetary policy (Germany’s new LM3 would be to the right of the LM3 shown in the box).

查看原始摘录

A Tale of Three Countries: (a) If Germany had raised taxes in 1991, then the story probably would have turned out better. If Germany raised taxes, then more of the effort to restrain the excessive growth and overheating of the German economy would have been driven by a shift to the left of Germany’s IS curve (from IS2 back toward IS1), so less of the restraint would have come from the tightening of German monetary policy (Germany’s new LM3 would be to the right of the LM3 shown in the box). German interest rates would not have risen so much (maybe not at all). There would have been less (or no) pressure on France and Britain to tighten their monetary policies to try to match rising German interest rates. (b) If, instead, France had reduced taxes in 1991, the story also probably would have turned out better (at least for France). France could have used the assignment rule. Direct monetary

This chapter presents the analysis of the macroeconomy of a country ...

This chapter presents the analysis of the macroeconomy of a country that has a fixed exchange rate. As noted in the introduction, this analysis is important because some countries currently have fixed exchange rates or floating rates that are so heavily managed that they resemble fixed rates, and because there are ongoing discussions of proposals to return to a system of fixed rates among the world's major currencies.

查看原始摘录

This chapter presents the analysis of the macroeconomy of a country that has a fixed exchange rate. As noted in the introduction, this analysis is important because some countries currently have fixed exchange rates or floating rates that are so heavily managed that they resemble fixed rates, and because there are ongoing discussions of proposals to return to a system of fixed rates among the world's major currencies. We focus on defense of the fixed exchange rate through official intervention in the foreign exchange market.

Exercises

习题与答案

题目 1From the Balance of Payments to the Money Supply

Which of the following can be considered as domestic assets of a country's central bank?

  • A) Bank deposits at the central bank
  • B) The country's government bonds owned by the central bank
  • C) Foreign currency assets held by the central bank
  • D) Currency issued by the central bank

正确答案：B | The country's government bonds owned by the central bank

难度：1 Easy Bloom's：Remember

题目 2From the Balance of Payments to the Money Supply

The sum of currency issued by the central bank and bank deposits at the central bank is called

  • A) the money supply.
  • B) domestic assets.
  • C) the monetary base.
  • D) fractional reserves.

正确答案：C | the monetary base.

难度：1 Easy Bloom's：Remember

题目 3From the Balance of Payments to the Money Supply

Official intervention in the foreign exchange market to defend a fixed-exchange rate when the value of the country's currency is under downward pressure causes

  • A) international reserve holdings to fall.
  • B) a downward pressure on the country's interest rates.
  • C) no change in the liabilities of the central bank.
  • D) the domestic money supply to rise.

正确答案：A | international reserve holdings to fall.

难度：2 Medium Bloom's：Understand

题目 4From Money Supply Back to the Balance of Payments

Consider a country that has an official settlements balance surplus and is experiencing upward pressure on the exchange-rate value of its currency. Which of the following will NOT be true in this context?

  • A) The central bank of this country must intervene to buy foreign currency and sell domestic currency.
  • B) Its balance sheet will show an increase in official international reserve holdings.
  • C) Its balance sheet will show an increase in its liabilities.
  • D) For the regular bank that is involved in the intervention transaction, the central bank decreases the bank's deposits at the central bank.

正确答案：D | For the regular bank that is involved in the intervention transaction, the central bank decreases the bank's deposits at the central bank.

难度：2 Medium Bloom's：Understand

题目 5From Money Supply Back to the Balance of Payments

A(n) ________ of the money supply in a country ________ the domestic interest rates.

  • A) expansion; increases
  • B) expansion; decreases
  • C) contraction; decreases
  • D) contraction; has no impact on

正确答案：B | expansion; decreases

难度：2 Medium Bloom's：Understand

题目 6From Money Supply Back to the Balance of Payments

A(n) ________ in a country's money supply causes international capital

  • A) expansion; outflows.
  • B) expansion; inflows.
  • C) contraction; outflows.
  • D) contraction; stock to stabilize.

正确答案：A | expansion; outflows.

难度：2 Medium Bloom's：Understand

题目 7From Money Supply Back to the Balance of Payments

The initial impact of ________ the money supply ________ the balance of payments.

  • A) expanding; worsens
  • B) expanding; improves
  • C) contracting; worsens
  • D) contracting; has no effect on

正确答案：A | expanding; worsens

难度：2 Medium Bloom's：Understand

题目 8From Money Supply Back to the Balance of Payments

Assuming no effect on exchange rates, which of the following is likely to happen if the money supply in a country contracts?

  • A) Decline in the international price competitiveness
  • B) Rise in the interest rates
  • C) Fall in the inflow of financial capital
  • D) Rise in the real spending

正确答案：B | Rise in the interest rates

难度：2 Medium Bloom's：Understand

题目 9From Money Supply Back to the Balance of Payments

Following an expansion of the money supply, a government committed to maintaining a fixed exchange rate must

  • A) accept a surplus in its current account.
  • B) not use sterilized intervention.
  • C) increase its level of government expenditure and autonomous investments.
  • D) intervene in the foreign exchange market to sell foreign currency and buy domestic currency.

正确答案：D | intervene in the foreign exchange market to sell foreign currency and buy domestic currency.

难度：1 Easy Bloom's：Remember

题目 10Sterilization

Which of the following indicates taking an action to reverse the effect of official intervention on the domestic money supply?

  • A) Adjusting the country's interest rates
  • B) Implementing capital controls
  • C) Sterilization
  • D) Playing by the "rules of the game"

正确答案：C | Sterilization

难度：2 Medium Bloom's：Understand

题目 11Sterilization

If a country starts with a surplus in its official settlements balance, intervention to defend a fixed exchange rate will cause

  • A) the money supply to expand and the economy to grow.
  • B) both the money supply and the economy to contract.
  • C) the money supply to grow and the economy to contract.
  • D) the money supply to contract and the economy to grow.

正确答案：A | the money supply to expand and the economy to grow.

难度：2 Medium Bloom's：Understand

题目 12Sterilization

There are limits to the ability of monetary authorities to use sterilized intervention in the case of a deficit because

  • A) the central bank may be unwilling to increase its holdings of foreign currency beyond a certain limit.
  • B) the pressure from foreign countries to allow the domestic currency to appreciate will lead to large losses.
  • C) the central bank's ability to constantly obtain foreign currency for the sterilized intervention is constrained.
  • D) the export level is fixed and it cannot be allowed to drop.

正确答案：C | the central bank's ability to constantly obtain foreign currency for the sterilized intervention is constrained.

难度：2 Medium Bloom's：Understand

Manual Preview

教师手册摘录

Internal and External Balance with Fixed Exchange Rates

This chapter presents the analysis of the macroeconomy of a country that has a fixed exchange rate. As noted in the introduction, this analysis is important because some countries currently have fixed exchange rates or floating rates that are so heavily managed that they resemble fixed rates, and because there are ongoing discussions of proposals to return to a system of fixed rates among the world's major currencies. We focus on defense of the fixed exchange rate through official intervention in the foreign exchange market.

To see the effects of defense through intervention, it is useful to describe the balance sheet of the country's central bank. The central bank holds two types of assets relevant to our discussion—official international reserve assets (R) and domestic assets (D). Its two relevant liabilities are domestic currency and deposits that (regular) banks place with the central bank. These two liabilities are the country's monetary base. With fractional reserve banking by regular banks, the country's money supply can be a multiple of the size of its base of "high-powered money."

When the country has an official settlements balance surplus, and its central bank intervenes to prevent its currency from appreciating, the central bank must sell domestic currency and buy foreign currency. This increases the central bank's holdings of official reserves and increases its liabilities as the domestic currency is added to the economy. The domestic money supply increases, probably by a multiple of the size of the intervention. If the money supply expands, then in the short run interest rates decrease. The financial account tends to deteriorate, and the increase in real spending and income increases the demand for imports, so the current account balance also tends to decrease. The overall payments surplus decreases. This is pictured as a downward shift in the LM curve toward a triple intersection of the new LM curve and the initial IS and FE curves. (In addition, the price level is likely to increase, at least beyond the short run, so that the current account also deteriorates as the country loses some international price competitiveness.) Intervention to prevent a currency from depreciating (in the face of an overall payments deficit) causes the opposite changes.

Slide Outline

课件线索

  • Fixed Exchange Rates:
  • Central Bank Assets
  • Central Bank Liabilities
  • Monetary Base and Money Supply
  • From the Balance of Payments to the Money Supply
  • From the Money Supply Back to the Balance of Payments
  • Expanding the Money Supply Worsens the Balance of Payments with Fixed Rates
  • Sterilization
  • Full/Complete Sterilization
  • Monetary Policy with Fixed Exchange Rates
  • How Expansionary Fiscal Policy Affects the Balance of Payments with Fixed Rates
  • Fiscal Policy with Fixed Exchange Rates

NextLab Bridge

本章可联动的贸易分析实验

Mundell Trilemma Lab

将《Internal and External Balance with Fixed Exchange Rates》对应的理论或政策机制放到贸易分析实验室中做交互式验证。

NextLab