Lecture Material: International Economics By: Wijayanto Samirin and Garry Pawitandra Poluan and

Exchange Rates and Central Bank

In your book page Central Bank Accounting

Money supply equals to currency held by the public and various types of deposits the public has at regular banks Banks are obliged to hold a certain assets to back up these deposits – Also known as bank reserves – Money multiplier effect 4 Money, money, money

5 Implications of Money Supply Increase for Fixed Exchange Rates Increase in money supply = banks more willing to lend Interest rate drops Capital flows out Real spending, production, income rise Price level increases Current account balance worsens Overall payments balance worsens And LM shifts down

Central Bank’s initiative to offset changes in money supply due to intervention – Usually using Open Market Operations (domestic action) Sells domestic government bonds 6 Sterilization

7 Fiscal Policy with Fixed Exchange Rates Government spending rises or tax rates fall Interest rate risesCapital flows in Overall payments balance eventually worsens Real spending, production, and income rise Current account balance worsens Price level increases Effects on the IS-LM curve depend on the responsiveness of capital flows

Internal shocks Domestic monetary shock Domestic spending shock International capital flow shock International trade shock 8 Shocks to the Economy

Thank You