The Mundell-Fleming Model Mainstream Thinking on Open Macroeconomics

Thomas Dürmeier Exchange Rates Regulating Global Finance Enominal exchange rate between the euro and the dollar (eg. 1,17 euro/$ = 0,85 $/euro) ε real exchange rate (epsilon) measured in purchasing power our pespective: from USA to EU E = number of units of domestic currency you can get for one unit of foreign currgency example: E USD/EUR = 1,19 $/Euro domestic foreign

Thomas Dürmeier Exchange Rate 2 Regulating Global Finance example: E USD/EUR = 1,19 $/Euro depreciationE  ε  (value of currency decreases) appreciationE  ε  (value of currency increases) Real exchange rate: exchange between commodities one Volkswagen P* vs. one Cadillac P 1. Volkswagen with US-price:P* x E 2. In comparison to Cadillac:(P* x E)/P = ε

Thomas Dürmeier Investement/Savings - Liquidity/Money: IS-LM Regulating Global Finance IS:Y = C(Y-T) + I (Y,i) + G LM:M/P = Y L(i) LM IS T , G  M  i Y social product nominal interest rate - only commodity and captial market - price level is constant - Keynesian bias - short-run

Thomas Dürmeier Aggregated Supply and Demand: AS-AD Regulating Global Finance AD:Y t = Y(M/P t, G, T) AS:P t = P t-1 (1+μ) F(1-(Y t /L), z) AS μ , L , z  M , T , G  P Y social product price level AD In the long-run: only AS determines Y - IS-LM plus labor market - neutrality of money - monetaristic bias - long-run

Thomas Dürmeier AS-AD: Neutrality of Money Regulating Global Finance AD:Y t = Y(M/P t, G, T) AS:P t = P t-1 (1+μ) F(1-(Y t /L), z) AS M , T , G  P Y social product price level AD In the long-run: only AS determines Y Monetary policy has NO influence on output, only inflation. Only under certain circumstances.

Balance of Payment Current account –Exports - Imports = Trade balance –Investment Capital account –Increase in foreign holdings of US assets –Increase in US holding of foreign assets –Statistical discrepancy Commodity flows Capital flows

Thomas Dürmeier Exchange Rate Regimes Regulating Global Finance Free floating: no central bank intervention Managed floating: no fixed exchange rate goal, but central bank interventionb Target zones: exchange rate around a band with Crawling pegs: no fixed rate, but alinment rate and process Adjustable peg: exchangre rate fixed, no alienment Currency board: autonom body, which controls exchange rate target Fixed or peeged exchange rate: constant exchange rate Dollarisierung (dollarization), Euroisierung (euroization) or currency union World currency (Privatization of money) Source: Frankel, Jeffrey A., Sergio Schmukler und Luis Serven (2002), ”Verifiability and the Vanishing Intermediate Exchange Rate Regime”, in: Susan M. Collins und Dani Rodrik (Hrsg.): Brookings Trade Forum, The Brookings Institution.

Thomas Dürmeier Elements of Open Macroeconomics Regulating Global Finance Interest rate parity (Mundell-Fleming) Purchasing power parity (monetaristic open macro) Expectations Policy credibility

Thomas Dürmeier Mundell-Fleming Modell Regulating Global Finance IS:Y = C(Y-T) + I (Y,i) + G LM:M/P = Y L(i) LMIS i Y social product nominal interest rate E=E e /(1+i-i*) interest rate parity i E Exchange rate E

Thomas Dürmeier Mundell-Fleming Modell: flexible exchange rate and fiscal policy Regulating Global Finance IS:Y = C(Y-T) + I (Y,i) + G LM:M/P = Y L(i) LMIS GG i Y social product nominal interest rate E=E e /(1+i-i*) interest rate parity i E Exchange rate E appreciation

Thomas Dürmeier Fixed exchange rate and fiscal policy Regulating Global Finance IS:Y = C(Y-T) + I (Y,i) + G LM:M/P = Y L(i) LMIS GG i Y social product nominal interest rate E=E e /(1+i-i*) interest rate parity i E Exchange rateE IS‘ LM‘‘ Pressure on exchange rate