Posted at 10.05.2018
In the absence of any imported materials, price setting up in the open economy is identical to in closed overall economy, ie prices are placed as a mark-up on unit labour costs
When Î¸=1, wage environment curve is same as in closed current economic climate.
A surge in Î¸ raises the true cost of brought in goods and therefore reduces the price-setting real wage
Source: Carlin & Soskice, p353
The ERU curve is defined as the mixtures of the true exchange rate and result of which the wage-setting real income is add up to the price-setting real wage. At any point on the ERU curve, the true exchange rate, Î¸, is constant and inflation is constant.
On ERU curve, inflation constant; real exchange rate constant
At details above ERU curve, real income below WS curve so upwards pressure on inflation. Income too low to satisfy wage setters at this level of job. Home inflation above world inflation. Hence Î¸ falling, real wages rising
At tips below ERU curve, real wage above WS curve so downward pressure on inflation. Salary too high for wage-setting equilibrium given low degree of occupation. Home inflation below world inflation. Hence Î¸ increasing, real salary falling
AD curve shows mixture of real exchange rate, Î¸, and level of output, y, at which goods market is in equilibrium with local real interest equal to world real interest rate
AD curve is favorably sloped to the right on assumption that a more competitive exchange rate (high Î¸) increases aggregate demand and output
BT curve shows combination of real exchange rate (Î¸) and productivity (y) at which trade is balanced, ie x = m
BT curve positively sloped to the right. A more competitive exchange rate (high Î¸) raises exports and takes a higher-level of output to operate a vehicle up demand for imports to provide trade balance
To kept of the BT curve is a trade surplus; to right is a trade deficit
BT curve flatter than Advertisement curve.
Suppose economy at first in equilibrium at A and then exchange rate depreciates.
Aggregate demand boosted by higher exports and economy techniques to B on Advertising curve. There is now a trade surplus because outcome has not risen enough to boost imports by same amount as exports.
For a little open economy:
demand area is given by Advertisement curve. On AD curve, goods market in equilibrium and r = r* (world real interest)
supply side given by ERU curve. On ERU curve, inflation is constant
balance of trade equilibrium symbolized by BT curve
In short run, overall economy in goods market equilibrium on Advertising curve. That's, for confirmed nominal exchange rate and a given price level, degree of output is set by the Advertisement curve
In medium run, market must be on ERU curve. Only then is labour market in equilibrium. So in medium run, AD and ERU curves intersect
In long run, trade balance must also maintain equilibrium
Source: Carlin & Soskice, p362
A is short-run equilibrium (on Advertisement curve however, not ERU curve). Economy loses competitiveness and steps along Advertising curve to B.
B (and B') is medium-run equilibrium in that there is secure inflation. But at B there is a trade surplus.
Z is long-run equilibrium. At Z, labour market equilibrium coincides with the healthy trade level of output.
What might transfer the Advertising curve to intersect ERU and BT curves at Z?
Wealth results: At A, country is accumulating prosperity. May raise long term income and move Advertising curve to right
Market pressure: Persistent trade surplus of trade deficit may lead to a change in credit conditions
Political pressure: Surplus countries will come under political pressure at home to boost activity and operate at less unemployment rate. Also may be political pressure from abroad to adjust policies
What will be the key variations between an wide open and closed market?
Trade in Goods
Output is now able to differ from local demand because of net exports
Net exports depends upon the true exchange rate = national competitiveness C&S 9. 1
Trade in Assets
Uncovered Interest Parity
Common Website link is the Exchange Rate
Two alternative policy regimes
Flexible exchange rate
Fixed exchange rates or Monetary Union
Uncovered Interest Parity (C&S 9. 2. 2)
e=log real exchange rate
Rise signifies real depreciation, or gain in competitiveness, anticipated to
Lower home prices
Higher overseas prices
Extends IS/LM to open up economy
Implies under flex rates, monetary insurance policy effective, fiscal plan ineffective
Money demand: M/p=f(Y, r). If M and p are fixed, and r is set in steady talk about by UIP, then Y is also fixed in steady talk about - QED
If IS curve shifts in a nutshell run, higher rates of interest imply real understanding, crowding out next exports, returning IS curve to its original position in long run
Assumes set M - unrealistic today
Under fixed exchange rates, economic policy inadequate, fiscal insurance plan effective
Obvious - there is no independent monetary policy under fixed exchange rates
Equilibrium given by IS curve and overseas interest levels, LM curve endogenous
Monetary policy in an open overall economy under versatile exchange rates
UIP means that there are now two transmitting mechanisms by which interest rates effect demand
Through direct effects on investment and consumption
Through UIP, which changes the true exchange rate, which in turn influences online exports i. e. the demand for domestic production
Under UIP, the impact of a rise in interest levels on demand will rely upon expectations about how exactly long rates of interest will stay high.
This gives plan extra leverage, but it addittionally creates problems of 'taking care of expectations'
However, if utilization is frontward looking, then we have similar problems with direct interest rate effects.