Part 4

Chapter 14
International Trade, Capital Mobility,
and the Economy in the Short Run
Slide 1

Copyright 2002 McGraw-Hill Ryerson Limited

EFFECTS OF DISTURBANCE ON INCOME

AND NET EXPORTS
Table 14-1

Income
Net exports

Slide 2

Increase in
Home Spending

Increase in
Real
Foreign Income
Depreciation

+
+

+
+

Copyright 2002 McGraw-Hill Ryerson

THE EFFECTS OF A RISE IN FOREIGN INCOME

Figure 14-1
If foreign income
increases, the demand
for Canadian exports
increases, which
increases output
domestically.
Therefore, the IS curve
shifts outward.

Slide 3

Copyright 2002 McGraw-Hill Ryerson

THE INTERNATIONAL TRANSMISSION OF

AGGREGATE DEMAND DISTURBANCES
Table 14-2
AFFECTED COUNTRY OR GROUP
INITIATING COUNTRY OR GROUP (PERCENTAGE CHANGE IN INCOME)
(1 percent increase
United
in autonomous spending)States Germany
United States
Germany
Japan
Canada
OECD

Slide 4

1.47
0.05
0.04
0.06
1.81

0.23
1.25
0.05
0.03
2.38

Japan Canada
0.25
0.60
1.26
0.03
1.84

0.68
0.60
0.06
1.27
2.32

OECD
0.74
0.23
0.21
0.10
2.04

Copyright 2002 McGraw-Hill Ryerson

INTERNAL AND EXTERNAL BALANCE

UNDER FIXED EXCHANGE RATES
Figure 14-2
With perfect capital
mobility, external
equilibrium is only
attained where the
domestic interest rate
equals the foreign.

Slide 5

Copyright 2002 McGraw-Hill Ryerson

PAYMENTS IMBALANCES, INTERVENTION,

AND THE MONEY SUPPLY
WITH FIXED EXCHANGE RATES AND
PERFECT CAPITAL MOBILITY
Table 14-3
1.Tightening of money.
2.Increased interest rates.
3.Capital inflow, payments surplus.
4.Pressure for currency appreciation.
5.Intervention by selling home money and buying
foreign money.
6.Monetary expansion due to intervention lowers
interest rate.
7.Back to initial interest rates, money stock, and
payments balance.

Slide 6

Copyright 2002 McGraw-Hill Ryerson

IS-LM WITH A FIXED EXCHANGE RATE

Figure 14-3
If the Bank of Canada
attempted to increase the
money supply while
maintaining a fixed exchange
rate, the domestic interest rate
would decrease, which would
cause capital outflow and
depreciation pressure on the
exchange rate. This would be
contrary to the fixed exchange
rate policy. Therefore, the
central bank cannot
independently shift the LM
curve with a fixed exchange
rate.

Slide 7

Copyright 2002 McGraw-Hill Ryerson

GERMAN UNIFICATION
(percent of GNP)
Box 14-1
Table 1

Current account
Budget deficit
Interest rate

Slide 8

1989

1990

1991

1992

4.8
0.1
7.1

3.3
2.1
8.5

1.1
3.3
9.2

1.1
2.8
9.5

Copyright 2002 McGraw-Hill Ryerson

EXCHANGE RATE CHANGES AND

THE IS CURVE
Figure 14-4
In the short run we
assume that the
domestic and foreign
price levels are fixed, so
that a depreciation
causes an improvement
in the terms of trade,
which shifts the IS
curve to the right.

Slide 9

Copyright 2002 McGraw-Hill Ryerson

EFFECTS OF AN INCREASE IN THE DEMAND

FOR EXPORTS
Figure 14-5
As we saw in Figure 141, an increase in foreign
demand shifts the IS
curve outward.
However, at E the
exchange rate will
appreciate and the
economy will be driven
back to E.

Slide 10

Copyright 2002 McGraw-Hill Ryerson

EFFECTS OF AN INCREASE IN THE MONEY

STOCK
Figure 14-6
An increase in the
money stock decreases
the domestic interest
rate. Because the
domestic interest rate is
below the foreign, the
exchange rate will
depreciate and net
exports will increase,
shifting the IS curve
outward.

Slide 11

Copyright 2002 McGraw-Hill Ryerson

THE CANADIAN AND U.S. 90-DAY TREASURY

BILL RATES

Figure 14-7
The two interest rates move together, but they are not equal. The difference
may be explained by exchange rate expectations.

Slide 12

Copyright 2002 McGraw-Hill Ryerson

RESPONSE TO AN EXPECTED APPRECIATION

OF THE CANADIAN DOLLAR
Figure 14-8
Expectations of a
currency appreciation
shift the BP curve
downward. In
anticipation of the
appreciation there is a
speculative attack on the
currency, which reduces
competitiveness and
causes output to fall.

Slide 13

Copyright 2002 McGraw-Hill Ryerson

EFFECTS OF MONETARY AND

FISCAL POLICY UNDER
PERFECT CAPITAL MOBILITY
Table 14-4
Policy

Fixed Exchange Rates

Flexible Exchange Rates

Monetary expansion No output change;

reserve losses
equal to money increase

Output expansion;
trade balance
improves; exchange
depreciation

Fiscal expansion

No output change;
reduced net
exports; exchange
appreciation

Slide 14

Output expansion;
trade balance
worsens

Copyright 2002 McGraw-Hill Ryerson