1. Lecture 16: Mundell-Fleming model with a floating exchange rate
Rule: if result at a given exchange rate would be a BoP deficit, then result under floating is currency depreciation.
Implications of capital mobility
Monetary expansion: high κ => extra stimulus via net exports => more effect on Y.
Fiscal expansion: high κ => crowding out of net exports => less effect on Y.
Examples:
Monetary expansion and contraction (e.g., Japan, 2013 & 1990)
Fiscal expansions (e.g., US National Saving in early 1980s)
ITF220 - Professor J.Frankel

2. ITF220 - Professor J.Frankel
Monetary Expansion
k = 0
k > 0
k >> 0
i ↓ => capital outflow => more depreciation => higher net exports
ITF220 - Professor J.Frankel

3. k = 0 k > 0 k >> 0 Fiscal Expansion
i ↑ => capital inflow => less depreciation => lower net exports
ITF220 - Profe J.Frankel

4. Example of monetary expansion: Abenomics depreciated the yen 2012-2013
House of representatives dissolved, Nov => “Abenomics”
“Abenomics: Progress, prospects and how the 2020 Tokyo Olympics can help solve Japan’s debt problem”
Takatoshi Ito, ADB Institute DEC.30,

5. ITF220 - Professor J.Frankel
Examples of monetary contractions under modern conditions of high κ and floating exchange rates
Thatcher monetary contraction of
Volcker monetary contraction of
Japanese monetary contraction of IS
IS’
LM' LM A B i y
In each case, i ↑ , r ↑ (at A) => currency appreciated => net exports fell (B)
=> recession was more severe than in traditional monetary tightenings.
ITF220 - Professor J.Frankel

6. Examples of monetary/ fiscal mix: 1) Reagan- omics, 1981-84;
2) German union
GDP composition shifts to G & C, away from I & X-M.
ITF220 - Professor J.Frankel

7. API-120 - Professor Jeffrey Frankel, Harvard University
We now have a causal interpretation of the NS identity
US National Saving, Investment & Current Account as Shares of GDP,
Gap widened,
as NS fell relative to I
API Professor Jeffrey Frankel, Harvard University

8. ITF220 - Professor J.Frankel
When US interest rates rise, the capital flow response puts downward pressure on Emerging Markets.
In Mundell-Fleming terms, rise in i* shifts up their BP=0 curve .
“Taper talk,” May/June 2013
ITF220 - Professor J.Frankel
Financial Times, Dec. 15, 2013

9. Appendix: Japanese monetary expansion and yen depreciation 2012-13
“Abenomics”

10. QE: The Fed doubled the monetary base in 2008.
The BoJ in early 2013 announced it would double over 2 years.
“HSBC: don’t worry, BoJ expansion will offset end of QE,” FT, Jun 14,

11. Japan’s monetary easing under Abenomics
raised the exchange rate (Yen/$) and stock market
HR dissolved, Nov => “Abenomics”
“Outlook Recovery on a shaky footing,” Special , Economic Research Dept., Rabobank November 13, 2013,

12. Abenomics seemed to boost growth, at least at first.
Nov => “Abenomics”
Mar. 10, 2014