Intermediate
Macroeconomics
Lecture 16
2
Interest-Rate Differentials
? Country risk & ex-rate expectations
1,Country risk
Political upheaval
? default on loan repayments
? higher i-rate to compensate
2,Ex-rate expectations
expect RMB to appreciate
? loans in RMB can pay a lower i-rate
3
Interest-Rate Differentials
? $100,RMB 8/$,US,5%,How large should
the i-rate be in China,so that returns in 2
countries will be the same after 1 year?
Depends…
on the ex-rate after 1 year
How can we know the ex-rate after 1 year?
? depends on expectation
4
Interest-Rate Differentials
If expected ex-rate is still RMB 8/$
? 5%
If expected ex-rate is RMB 7/$
100 * (1+5%) = $105
$105 * RMB 7/$ = RMB 735
800 * (1+i) = 735
i = - 8.125%
5
Interest-Rate Differentials
? Differentials in the M-F Model
??? *rr
)()*()( eNXGrITYCEY ??????? ?
),*(/ YrLPM ???
6
Interest-Rate Differentials
political turmoil or expect e↓
? risk premium ↑
Y
e
IS*
LM*
7
Interest-Rate Differentials
Implication,
although i↑ and I ↓,the depreciation of
the currency stimulates NX by a
greater amount,so that aggregate
income/output ↑
8
Interest-Rate Differentials
? However,such a boom does not occur!
1,Central bank will defend the currency
2,P for imports↑? M/P↓
3,Risk premium↑ & D for money↑
simultaneously (M/P = L (r*+θ,Y))
9
Interest-Rate Differentials
? Mexico 1994-95
Beginning of 1994,NAFTA
Political situation
Risk premium ↑ under fixed ex-rate
End of 1994,devaluation of peso
Risk premium ↑ further
Stock market crashed
Government hard to get new bonds issued
10
Interest-Rate Differentials
? Asia 1997-1998
Thailand,South Korea,Indonesia…
Asian banking system
(high default rate of loans due to govern,
Intervention in the banking system)
11
Interest-Rate Differentials
? Vicious circle
Default problems in the banking system
? Confidence↓
? Risk premium and i-rate↑
? Price of stock and other assets ↓
? Value of collateral for bank loans ↓
? Greater default exacerbated problems
12
Should Ex-Rate Be Floating
or Fixed?
? Floating,freedom of monetary policy
? Fixed,
1) ex-rate uncertainty makes trade
more difficult
2) Discipline a nation’s monetary
authority
13
Should Ex-Rate Be Floating
or Fixed?
? Monetary union in the U.S,and Europe
Pros,travel,trade,& business costs↓
political advantage
Cons,lose national monetary policy
14
Should Ex-Rate Be Floating
or Fixed?
? Why is monetary union a bad idea
of Europe?
1,Mobility of labor
2,Power of the central government
15
Should Ex-Rate Be Floating
or Fixed?
? 经济结构决定论, 小型开放经济国家及
出口产品结构较为单一的国家，实行固
定汇率制较好 ;
(Speculative attacks,currency boards,and
dollarization)
? 经济冲击决定论
16
Should Ex-Rate Be Floating
or Fixed?
? 政策搭配论：其他政策（资本管制）
? 成本收益决定论
? 依附决定论
17
Should Ex-Rate Be Floating
or Fixed?
? 人民币升值？汇率更加灵活？
94-97灵活 8.7--8.28； 97后固定
外汇储备 ↑
为固定汇率投放基础货币 ↑ （ 宏观调控）
钉美元，美元贬值
贸易账户顺差大
进口商品及旅游
18
Should Ex-Rate Be Floating
or Fixed?
? 人民币不可兑换，外汇市场不健全
? 利率改革在先、汇率改革在后
? 热钱
? 出口，就业，经济增长
? 直接投资
19
Mundell-Fleming Model w/ a
Changing P Level
Y
e LM*
IS*
Y
P
Y1
P1
P2
Y2
AD
20
Mundell-Fleming Model w/ a
Changing P Level
SRAS
LRAS
Y*
Y
e LM*
IS*
Y
P
AD
21
Large Open Economy
? Goods market
Y = C(Y-T) + I (r) + G + NX (e)
? Money market
M/P = L (r,Y)
? Exchange market
NX (e) = NFI (r)
22
Large Open Economy
? Expansionary fiscal policy
r
Y
IS
LM
r
NFI
NFI
NX
e
NX
NFI
23
Large Open Economy
? Expansionary monetary policy
NX
e
NX
NFI
r
Y
IS
LM
r
NFI
NFI
24
A Rule of Thumb
? To find how any policy will affect any
variable,find the answer in the two
extreme cases and take an average,
25
A Rule of Thumb
Ex-rate regime S
浮
O E
动
封 闭 L O E
r Y e NX r Y e NX r Y e NX
Fiscal expansion - 0 ↑ ↓ ↑
↑ - -
Monetary
expansion
- ↑ ↓ ↑ ↓
↑ - -
Import restriction - 0 ↑ 0 - - - -