1. 2 1 3 S Y 11 The Transition In the transition: P  so that DD-curve shifts to the left so that AA-curve shifts to the left

2. 12 1 2 3 Y S A Permanent Fiscal Expansion (3 - transitory fiscal expansion) AA shifts down because Result: Monetary policy is effective in the short run while fiscal policy is not effective.

3. 13 S S S Y YY 2 1 Change in (assume thatis given)

4. 14 Phillips Curve)given) 0 Long run Short Run

5. 15 Japan 1999 slump zero rate of interest (liquidity tramp) Expanded Fiscal Policy ( Deficit = 7-8% of GDP ) S Y DD DD’ AA Yen appreciated 12 percent in the May - September period vis a vis $ Output growth for 2000: 0.5% forecast

6. 16 D D CA=0 Results: (1) monetary policy is ineffective (2) fiscal policy is effective Capital Controls

7. Closed Capital Account marginal propensity to consume marginal propensity to import 17

8. 18 Open Capital Account open economy multiplier

9. 19 Closed Capital Account (1) (2) open economy multiplier closed economy multiplier

10. Exchange-rate/Capital-flows Possibilities Triangle Capital Controls flexible exchange rate fixed exchange rate 3 Policy Targets: (1) stabilized exchange rate fluctuations (2) stabilized output fluctuations (3) economic freedom 20 stabilized output fluctuations stabilized exchange rate fluctuations economic freedom