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Session 22

Session 22. How Does the Open Macro-economy Work?. National Macro-economic Performance Goals. Internal Balance. Full employment, or an acceptably low unemployment rate. Price stability, or an acceptably low inflation rate. External balance.

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Session 22

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  1. Session 22 How Does the Open Macro-economy Work?

  2. National Macro-economic Performance Goals • Internal Balance • Full employment, or an acceptably low unemployment rate • Price stability, or an acceptably low inflation rate • External balance • Sustainable composition of the country’s balance of payments with the rest of the world

  3. A Basic Framework for Macro-economic Analysis • Domestic production depends on aggregate demand. GDP = C + I + G + (X – M) Aggregate Expenditure = C + I + G + (X – M) Aggregate Demand = C + I + G + (X – M) Inflation =

  4. Trade depends on income.

  5. A More Complete Framework : Three Markets Mundell – Fleming Model • The Domestic Product Market • The Money Market • The Foreign Exchange Market (Balance of Payment)

  6. The Investment – Saving Curve (Product Market) up IS2 Some Exogenous shocks that shift the IS curve up (or to the right) • An increase in government spending or a tax cut • An improved customer expectations about the future • The shift in the tastes of foreign customers toward the country’s products.

  7. The Liquidity – Money Curve (Money Market) LM2 Down Some Exogenous shocks that shift the LM curve down (or to the right) • An increase in government spending or a tax cut • A decrease in average price level ( i.e., due to a decline in oil prices) • The introduction of credit cards.

  8. The Foreign Exchange Market (or Balance of Payment) The country’s currency value decrease (i.e., from ฿ 25/ $ 1 to฿ 50/ $ 1) FE2 Inflow < Outflow(Export < Import) Down Inflow > Outflow(Export > Import) Some Exogenous shocks that shift the FEcurve down (or to the right) • An increase in exports • A decrease in imports • A decrease in foreign interest rate • A increase in the expected rate of appreciation of the country’s currency

  9. ฿ 25/ $ 1 the expected rate of appreciation ฿ 20/ $ 1 Based on the expectation, the dollar holders could make the profit as follows Now Future ฿ 5 (profit) $ 1 ฿25 $ 1 ฿ 20 = $1 (cost) As a result of the expected rate of appreciation, the following happens More inflow dollars More demand for baht The value of baht will decrease (฿ 25/ $ 1 to ฿30/ $1)

  10. Macro-economic Policies

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