Keynesian Model of the trade balance TB & income Y.
Key assumption: P fixed => .
Mundell-Fleming model Key additional assumption: international capital flows KA respond to interest rates i.
LECTURE 2:The Mundell-Fleming Model with a Fixed Exchange Rate
YY
M
A
P
Questions: Effect of fiscal expansion or other .
Effect of monetary expansion / .
ALTERNATE APPROACHES TO DETERMINATION OF EXTERNAL BALANCE
Elasticities Approach to the Trade Balance
Keynesian Approach to the Trade Balance
Mundell-Fleming Model of the Balance of Payments
Monetary Approach to the Balance of Payments
NonTraded Goods or Dependent-Economy Model of the Trade Balance
Intertemporal Approach to the Current Account
KEYNESIAN MODEL OF THE TRADE BALANCE Import demand is a function of the exchange rate & income. The same for exports: => TB = X(E, Y*) – IM(E, Y), where IM is here defined to be import spending expressed in domestic terms.
.
If the domestic country is small, Y* is exogenous; drop it for simplicity. Rewrite TB = .
0dE
dX
0**
mdY
dX0m
dY
dIM
X
mYEX )(
0dE
dIM
0dE
Xdand we assume the Marshall-Lerner condition holds: .
Notationally, we embody all E effects (whether via exports or imports) in ;
STYLIZED J-CURVES
With instantaneouspass-through to import prices
With delayedpass-throughto import prices
Empirical estimates of sensitivity of exports and imports to E & Y
• For empirical purposes, we estimate by OLS regression– with allowance for lags, giving J-curve;– controlling for income Y & Y* as well as E,– shown in logs, giving parameters as:
• price elasticities & income elasticities.
• Illustration: Marquez (2002) finds for most Asian countries:– Marshall-Lerner condition holds, after a couple of years, and – income elasticities are in the 1.0-2.0 range.
)/*log( PEP
log X
Estimated price elasticities (LR)
satisfy the Marshall-Lerner
Condition.Estimated income elasticities are mostly
between 1.0 - 2.0.
An application of the marginal propensity to import:
Bussière, Callegari, Ghironi, Sestieri, & N.Yamano, 2013,"Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-2009."
Why did trade fall so much more sharply than income in the 2008-09 global recession?
2009
Bussière, Callegari, Ghironi, Sestieri, & Yamano, 2013, "Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-09."
Why did trade fall so sharply in the 2008-09 global recession?
The usual explanations involve trade credit, inventories, and trade in intermediate inputs.
Behavior of real components of GDP in the 2008-09 recession
Demand, adjusted for import-intensity
GDP
Investment
Imports & Exports
Bussière, Callegari, Ghironi, Sestieri, & N.Yamano, "Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-2009.“
Bussière et al (2013) argue that Investment, which declined much more in 2009 than the other components of GDP, has
a higher marginal propensity to import than the other components.
Trade Balance = TB = (E) – mY.
Aggregate output = domestic Aggregate Demand + net foreign demand: Y = A(i, Y) + TB(E, Y),
More specifically, let A(i, Y) = Ā - b(i) + cY ,
where the function -b( ) captures the negative effect of the interest rate i on investment spending, consumer durables, etc.
Solve to get the IS curve:
where s 1 – c is the marginal propensity to save.
X
ms
EXibAY
)()(
where and .0di
dA0c
dY
dA
mYEXcYibA )()(Combining equations,
Y =
msEXibA
Y )()(
IS curve: An inverse relationship between i and Y consistent with the equilibrium that supply = demand in the goods market.
,AAn increase in spending, Ā,e.g., a fiscal expansion, shifts IS
to the right by the multiplier 1/(s+m).
The overall balance of payments is given by
BP = TB + KA ,
where , the degree of capital mobility > 0.
We want to graph BP = 0. Solve for the interest rate:
*)()( iiKAmYEX
*)( iid
dKA
YmKAXii )/())(/1(*)(
The Mundell-Fleming model introduces capital flows:
slope = m/
Finally, the LM curve is given by = L ( i, Y)
where , . 0
dY
dL0
di
dL
A monetary expansion shifts the LM curve to the right .
LM´
• Do central banks actually set M?• Supposedly they set M1, in the 1980s heyday of monetarism.• Also the monetary base made a comeback after 2008: Quantitative
Easing.
• Normally they think in terms of setting i.• Still, the role of the LM equation can be taken by a Taylor Rule,• which describes central banks as setting i in response to Y & inflation.
→
Appendix: Causes of Developing Country BoP Surpluses 2003-08 & 2010-13
• Strong economic performance (especially China & India) -- IS shifts right.
• Easy monetary policy in US and other major industrialized countries (low i*)
-- BP shifts down.
• Big boom in mineral & agricultural commodities (esp. Africa & Latin America)
-- BP shifts right.
Causes of BoP Surpluses in Developing Countries1990-1997, 2003-08 &2010-13
I. “Pull” Factors (internal causes)1. Monetary stabilization => LM shifts up
2. Removal of capital controls => κ rises
3. Spending boom => IS shifts out/up
II. “Push” Factors (external causes)1. Low interest rates in rich countries
=> i* down
=>2. Boom in export markets =>
BP shifts downout}
•