Lesson 32
THE MUNDELL-FLEMING MODEL (CONTINUED) & THE THREE MODELS OF
AGGREGATE SUPPLY
WHY INCOME MIGHT NOT RISE?
x The central bank may try to prevent the depreciation by reducing the money supply.
x The depreciation might boost the price of imports enough to increase the price level
(which would reduce the real money supply).
x Consumers might respond to the increased risk by holding more money.
Each of the above would shift LM* leftward.
THE SOUTH EAST ASIAN CRISIS
Exchange rate%
change from 7/97 to
1/98
Stock market %
change from 7/97
to 1/98
Nominal GDP%
change 1997-98
Indonesia -59.4% -32.6% -16.2%
Japan -12.0% -18.2% -4.3%
Malaysia -36.4% -43.8% -6.8%
Singapore -15.6% -36.0% -0.1%
S. Korea -47.5% -21.9% -7.3%
Taiwan -14.6% -19.7% n.a.
Thailand -48.3% -25.6% -1.2% (1996-97)
U.S. n.a. 2.7% 2.3%
FLOATING VS. FIXED EXCHANGE RATES
Argument for floating rates:
Allows monetary policy to be used to pursue other goals (stable growth, low inflation).
Arguments for fixed rates:
Avoids uncertainty and volatility, making international transactions easier.
Disciplines monetary policy to prevent excessive money growth & hyperinflation.
MUNDELL-FLEMING AND THE AD CURVE
Previously, we examined the M-F model with a fixed price level. To derive the AD curve, we
now consider the impact of a change in P in the M-F model. We now write the M-F equations
as:
(Earlier, we could write NX as a function of e because e and
H
move in the same direction
when P is fixed.)
DERIVING THE AD CURVE
AD curve has negative slope because:
As P ๎ p(M/P) ๎ LM shifts left ๎
H
๎ pNX ๎ pY
( ) ( ) ( ) ( )*
YCYTIr GNX๎
๎๎ ๎๎
IS*
( ) ( , )*
MP Lr Y
LM*
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