Central banks macro_adjustments
-
date post
19-Oct-2014 -
Category
Documents
-
view
442 -
download
1
description
Transcript of Central banks macro_adjustments
Central Banks
Macro - Adjustment Strategies
Central Banks & Exchange Rate Regimes
Flexible Fixed Managed Floating
Flexible Exchange Rate
Exchange rates are freely determined by the demand & supply of currencies.
Increase in Demand for £ Under Flexible Exchange Rate
D£
S£
e$/£
Q£
D£’
e
e’
Fixed Exchange Rate Gold standard (up to 1914)
Peg currency to gold at a mint parity. ($20.67/ounce of gold, £4.25/ounce of gold).
Fixed Exchange Rate Gold standard Pegged rate system
Peg is the central value of exchange rate around which the government maintains narrow limits. (Haitian Gourde = $.20 since 1907 for a long period of time).
Government intervenes in foreign exchange markets to maintain the exchange rate within prescribed limits.
Increase in Demand for £ Under Pegged Rate System
D£
S£
e$/£
Q£
S£’
D£’
ē
Fixed Exchange Rate Devaluation
Peg is increased. • £ was devalued in Nov. 1967 from $2.80/£ to
$2.40/£ . Revaluation
Peg is decreased.
Managed Floating
Government intervenes in the foreign exchange market to influence the exchange rate, but does not commit itself to maintain a certain fixed rate or some narrow limits around it.
Goods Market Equations
Y = C + I + G0 + NX (Equim condition) C = C0 + cYd (Consn function) Yd = Y – T + R0 (Disposable
income) T = T0 + tY (Tax function) I = I0 – br (Investment
function)
Goods Market Equations
Parameters
c: MPC t: Personal Tax Rate b: Interest Sensitivity of I
C0 : Exogenous Component of C
I0 : Exogenous Component of I
G0 : Government Expenditure
R0 : Transfer Payments
T0 : Fixed personal tax revenue
Endogenous Variables
Y: National Income C: Consumption Yd: Disposable Income T : Personal Tax Revenue I : Investment
Goods Market Equilibrium:IS Curve (General form) Goods market equilibrium condition:
AS = ADÞ Sn – I = NXÞ - A0 + br + sY = NX0 – mYÞ r = (A0 + NX0)/b – (s + m)/b*Y
= (A0 + NX0)/b – 1/αb*Y where
A0 = C0 + c(R0 – T0) + I0 + G0
NX0 = X0 – Q0 + (g + j)eP*/P
α = 1/[1 – c(1 – t) + m]
Goods Market Equilibrium:IS Curve (Particular form)
r = A0 =
Open economy multiplier 1/(s+m) =
IS Curve
Y
r
S
I[A0 + NX0/b
-1/b
Assets Markets
Markets in which money, bonds, stocks, real estate & other forms of wealth or stores of value are exchanged.
We consider two types of assets domestic bonds domestic money
Total Real Wealth in the Economy Supply of real wealth
W/P = M/P + VS whereW : Nominal wealthP : General price levelVS: Stock of bonds
Demand for real wealth W/P = L + V
L: Demand for moneyV: Demand for bonds
In equilibrium L + V = M/P + VS
Or (L - M/P) + (V - VS) = 0
Walras law
As long as money market is in equilibrium (i.e. L = M/P), bond market will also be in equilibrium.
Money Market Equations
L = M/P (Money market equim condition)
L = L0 + kY – hr (Money demand)
M = uH (Money supply)
H = IR + CBC0 (High Powered
Money)
IR = IR-1 + BP-1 (Int. Reserves adjustment)
Money Market Equations
Endogenous Variables
L: Liquidity Demand r: Real interest Rate M: Nominal Money Supply H: High-Powered Money IR: International Reserves P: General Price Level CBC0: Central Bank Credit
Exogenous Variables
k: Income Sensitivity of L h: Interest Sensitivity of L u: Money Multiplier L0: Exogenous component of L
Demand for Money
The demand for money can be linearized to:
L = L0 + kY – hr
Supply of Money
MS = Cp + CD
Cp: Currency (coin, dollar notes) in the
hand of the publicCD: Checkable deposits
M = H where : the money multiplier H: the high powered money (monetary base)
Central Bank’s Balance Sheet Assets = IR + CBC Liabilities = Cp + RE
IR + CBC = Cp + RE = H H is created when the Central Bank acquires
assets in the form of international reserves, IR (foreign exchange & gold), & Central Bank credit, CBC (loans, discounts & government bonds).
Simplified Central Bank Balance Sheet
Assets Claims
International Reserves $100b
Central Bank Credit $200b
High Powered Money $300b
Currency $240b
Cash in vaults $20b
Currency in the hand of the public $220b
Deposits at the central bank $60b
High Powered Money $300b
Effects of Open Market Purchase on Central Bank’s Balance Sheet Central bank purchase of securities (increase in
CBC). Central bank check is deposited in the
commercial bank. If the commercial bank decides to convert the
check into cash, the currency in vault (RE) increases.
If commercial bank deposit the check at the central bank, commercial bank deposit (RE) increases.
Effects of a Drain of International Reserves on Central Bank’s Balance Sheet
IR decreases & Commercial bank deposit decreases. A BP deficit (surplus) decreases (increases) H &, therefore, tends to decrease (increase) MS.
Money Market Equilibrium: The LM Curve
MS/P = L0 + kY – hr
r = (L0 - MS/P)/h + k/h Y Particular: r =
LM Curve
Y
r
L
M
[L0-MS/p]/h
k/h
Immediate-run Equilibrium Immediate-run equilibrium is obtained when
both the product & the money markets are in simultaneous equilibrium. It occurs for a given level of fixed MS.
Immediate-run Equilibrium
Y
r
S
I
L
M
YE
rE
Foreign Trade Equations
BP = 0 (Foreign sector equim condition)
BP = NX + CF (Balance of Payments)
NX = X – Q (Net Export function)
X = X0 + gePW/P (Export function)
Q = Q0 + mY – jePW/P (Import function)
e = e-1 – qBP (Exchange Rate adjustment)
CF = f(r – rW) (Capital Flow equation)
Foreign Trade Equations
Endogenous Variables
NX : Net Exports (Trade Surplus) X : Value of Exports Q : Value of Imports BP : Balance of Payments
Surplus CF : Capital Flow (KAB Surplus) e : Exchange Rate (Domestic/Foreign Currency)
Exogenous Variables
g : Exchange Rate Sensitivity of X
m : Marginal Propensity to Imp.
j : Exch. Rate Sensitivity of Q
f : Capital Mobility Coefficient
q : Exchange Rate Coefficient
rW : World Interest Rate
X0 : Exogenous Component of X
Q0 : Exogenous Component of Q
Foreign Trade Sector Equilibrium: The BP Curve BP = 0 => NX + f (r – rW) = 0 With no capital mobility (f = 0)
NX = NX0 - mY = 0
Y = NX0/m
With perfect capital mobility r = rW
With imperfect capital mobility NX0 – mY + f (r – rW) = 0
=> r = [rW - NX0/f] + m/f * Y
BP with No Capital Mobility
Y = NX0/m
In particular form: Y =
BP Curve with No Capital Mobility
Y
r BP
NX0/m
BP Curve with Perfect Capital Mobility
Y
r
BPr = rW
BP Curve with Imperfect Capital Mobility
Y
r
BP
Short-run Equilibrium An immediate-run equilibrium sustaining a BP
deficit & losses of international reserves leads to a decline in MS & a leftward shift of the LM curve.
A short-run equilibrium exists when all the three markets are in equilibrium.
Short-run Equilibrium withNo Capital Mobility
Y
r
S
I
L
M
YE
rE
BP
Short-run Equilibrium withPerfect Capital Mobility
Y
r
S
I
L
M
YE
rE BP
Short-run Equilibrium with Imperfect Capital Mobility
Y
r
S
I
L
M
YE
rE
BP
Sterilization Operations
Operations carried out by the Central Bank in order to neutralize the effects that its intervention in foreign exchange markets has on H.
H = IR + CBC = 0or CBC = - IR