Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.
Central BanksMacro - Adjustment Strategies
Central Banks & ExchangeRate 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       e$/£                   S£   e’   e                         D£’ ...
Fixed Exchange Rate Gold   standard (up to 1914)   Peg currency to gold at a mint parity.   ($20.67/ounce of gold, £4.25...
Fixed Exchange Rate Gold standard Pegged rate system     Peg is the central value of exchange rate      around which th...
Increase in Demand for £Under Pegged Rate System  e$/£                   S£                        S£’  ē                 ...
Fixed Exchange Rate   Devaluation       Peg is increased.         • £ was devalued in Nov. 1967 from $2.80/£ to         ...
Managed Floating   Government intervenes in the foreign    exchange market to influence the    exchange rate, but does no...
Goods Market Equations Y = C + I + G0 + NX (Equim condition) C = C0 + cYd           (Consn function) Yd = Y – T + R0   ...
Goods Market Equations    Endogenous Variables                  Parameters   Y: National Income            c: MPC   C: ...
Goods Market Equilibrium:IS Curve (General form)   Goods market equilibrium condition:    AS = AD     Sn – I = NX     - A...
Goods Market Equilibrium:IS Curve (Particular form)   r=A0 =Open economy multiplier 1/(s+m) =
IS Curve          r[A0 + NX0/b     I              -1/ b                      S                          Y
Assets Markets Markets in which money, bonds, stocks,  real estate & other forms of wealth or  stores of value are exchan...
Total Real Wealth in the Economy   Supply of real wealth       W/P = M/P + VS where        W : Nominal wealth        P :...
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 Market Equations    Endogenous Variables               Exogenous Variables   L: Liquidity Demand             k: In...
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 public  CD: Checkable deposits M = H...
Central Bank’s Balance Sheet   Assets = IR + CBC   Liabilities = Cp + RE   IR + CBC = Cp + RE = H   H is created when ...
Simplified       Central Bank Balance Sheet                 Assets                                        ClaimsInternatio...
Effects of Open Market Purchaseon Central Bank’s Balance Sheet   Central bank purchase of securities (increase in    CBC)...
Effects of a Drain of International Reserves     on Central Bank’s Balance Sheet   IR decreases & Commercial bank    depo...
Money Market Equilibrium:The LM Curve MS/P = L0 + kY – hr r = (L0 - MS/P)/h + k/h Y Particular:r=
LM Curve          r                        M              L   k/h                            Y[L0-MS/p]/h
Immediate-run Equilibrium   Immediate-run equilibrium is obtained when    both the product & the money markets are in    ...
Immediate-run Equilibrium   r                M       I  rE       L            S                        Y           YE
Foreign Trade Equations   BP = 0      (Foreign sector equim condition)   BP = NX + CF         (Balance of Payments)   N...
Foreign Trade Equations    Endogenous Variables                     Exogenous Variables   NX : Net Exports (Trade Surplus...
Foreign Trade Sector Equilibrium:The BP Curve   BP = 0 => NX + f (r – rW) = 0   With no capital mobility (f = 0)     NX...
BP with No Capital Mobility   Y = NX0/m   In particular form:    Y=
BP Curve withNo Capital Mobility   r         BP                      Y            NX0/m
BP Curve withPerfect Capital Mobility    rr = rW                 BP                            Y
BP Curve withImperfect Capital Mobility   r                      BP                             Y
Short-run Equilibrium   An immediate-run equilibrium sustaining a BP    deficit & losses of international reserves leads ...
Short-run Equilibrium withNo Capital Mobility   r       BP                M       I  rE       L            S              ...
Short-run Equilibrium withPerfect Capital Mobility   r                    M       I  rE                    BP           L ...
Short-run Equilibrium withImperfect Capital Mobility   r                    M       I                BP  rE           L   ...
Sterilization OperationsOperations carried out by the Central Bank in order to neutralize the effects that its interventi...
Upcoming SlideShare
Loading in …5
×

Central Banks Macro Adjustments

1,241 views

Published on

Central Banks, macroeconomic adjustments.

Published in: Economy & Finance
  • Be the first to comment

Central Banks Macro Adjustments

  1. 1. Central BanksMacro - Adjustment Strategies
  2. 2. Central Banks & ExchangeRate Regimes Flexible Fixed Managed Floating
  3. 3. Flexible Exchange Rate Exchange rates are freely determined by the demand & supply of currencies.
  4. 4. Increase in Demand for £Under Flexible Exchange Rate e$/£ S£ e’ e D£’ D£ Q£
  5. 5. 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).
  6. 6. 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 = $.20 since 1907 for a long period of time).  Government intervenes in foreign exchange markets to maintain the exchange rate within prescribed limits.
  7. 7. Increase in Demand for £Under Pegged Rate System e$/£ S£ S£’ ē D£’ D£ Q£
  8. 8. Fixed Exchange Rate Devaluation  Peg is increased. • £ was devalued in Nov. 1967 from $2.80/£ to $2.40/£ . Revaluation  Peg is decreased.
  9. 9. 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.
  10. 10. 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)
  11. 11. Goods Market Equations Endogenous Variables Parameters Y: National Income  c: MPC C: Consumption  t: Personal Tax Rate Yd: Disposable Income  b: Interest Sensitivity of I T : Personal Tax Revenue  C0 : Exogenous Component of C I : Investment  I0 : Exogenous Component of I  G0 : Government Expenditure  R0 : Transfer Payments  T0 : Fixed personal tax revenue
  12. 12. Goods Market Equilibrium:IS Curve (General form) Goods market equilibrium condition: AS = AD Sn – I = NX - A0 + br + sY = NX0 – mY r = (A0 + NX0)/b – (s + m)/b*Y = (A0 + NX0)/b – 1/αb*Y whereA0 = C0 + c(R0 – T0) + I0 + G0NX0 = X0 – Q0 + (g + j)eP*/Pα = 1/[1 – c(1 – t) + m]
  13. 13. Goods Market Equilibrium:IS Curve (Particular form) r=A0 =Open economy multiplier 1/(s+m) =
  14. 14. IS Curve r[A0 + NX0/b I -1/ b S Y
  15. 15. 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
  16. 16. Total Real Wealth in the Economy Supply of real wealth  W/P = M/P + VS where W : Nominal wealth P : General price level VS: Stock of bonds Demand for real wealth  W/P = L + V L: Demand for money V: Demand for bonds In equilibrium  L + V = M/P + VS  Or (L - M/P) + (V - VS) = 0
  17. 17. Walras law As long as money market is in equilibrium (i.e. L = M/P), bond market will also be in equilibrium.
  18. 18. 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)
  19. 19. Money Market Equations Endogenous Variables Exogenous Variables L: Liquidity Demand  k: Income Sensitivity of L r: Real interest Rate  h: Interest Sensitivity of L M: Nominal Money Supply  u: Money Multiplier H: High-Powered Money  L0: Exogenous component of L IR: International Reserves P: General Price Level CBC0: Central Bank Credit
  20. 20. Demand for Money The demand for money can be linearized to: L = L0 + kY – hr
  21. 21. Supply of Money MS = Cp + CD Cp: Currency (coin, dollar notes) in the hand of the public CD: Checkable deposits M = H where  : the money multiplier  H: the high powered money (monetary base)
  22. 22. 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).
  23. 23. Simplified Central Bank Balance Sheet Assets ClaimsInternational Reserves $100b Currency $240 bCentral Bank Credit $200b Cash in vaults $20 b Currency in the hand of the public $220b Deposits at the central bank $60 bHigh Powered Money $300b High Powered Money $300 b
  24. 24. Effects of Open Market Purchaseon 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.
  25. 25. 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.
  26. 26. Money Market Equilibrium:The LM Curve MS/P = L0 + kY – hr r = (L0 - MS/P)/h + k/h Y Particular:r=
  27. 27. LM Curve r M L k/h Y[L0-MS/p]/h
  28. 28. 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.
  29. 29. Immediate-run Equilibrium r M I rE L S Y YE
  30. 30. 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)
  31. 31. Foreign Trade Equations Endogenous Variables Exogenous Variables NX : Net Exports (Trade Surplus)  g : Exchange Rate Sensitivity of X X : Value of Exports Q : Value of Imports  m : Marginal Propensity to Imp. BP : Balance of Payments  j : Exch. Rate Sensitivity of Q Surplus  f : Capital Mobility Coefficient CF : Capital Flow (KAB Surplus) e : Exchange Rate  q : Exchange Rate Coefficient (Domestic/Foreign Currency)  rW : World Interest Rate  X0 : Exogenous Component of X  Q0 : Exogenous Component of Q
  32. 32. 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
  33. 33. BP with No Capital Mobility Y = NX0/m In particular form: Y=
  34. 34. BP Curve withNo Capital Mobility r BP Y NX0/m
  35. 35. BP Curve withPerfect Capital Mobility rr = rW BP Y
  36. 36. BP Curve withImperfect Capital Mobility r BP Y
  37. 37. 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.
  38. 38. Short-run Equilibrium withNo Capital Mobility r BP M I rE L S Y YE
  39. 39. Short-run Equilibrium withPerfect Capital Mobility r M I rE BP L S Y YE
  40. 40. Short-run Equilibrium withImperfect Capital Mobility r M I BP rE L S YE Y
  41. 41. 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 = 0 or CBC = - IR

×