国际金融学教师1.课件lecture8the m-f model

1、2022/8/14Chinese Finance Research Institute1ContentsThe M-F Model: A Graphical IllustrationThe M-F Model: A Formal IllustrationAn Overall Appraisal The Eternal TriangleAssignments2022/8/14Chinese Finance Research Institute2The M-F Model: A Graphical IllustrationI. Introduction The model, a workhorse

2、 in international finance and open economy macroeconomics, was originally pioneered by Robert A. Mundell (1963; 1964) and Marcus Fleming (1962). If price stickiness is introduced, the model is extended to the so-called M-F-D model, where “D” refers to the Dornbuschs great contribution in 1976 which

3、we have already covered in the previous lecture. We will summarize the overall assumptions before presenting a brief analysis on the components of the model. 2022/8/14Chinese Finance Research Institute3II. AssumptionsA small open economy model (SOE)Price rigidity (the aggregate supply schedule is th

4、erefore horizontal, and there is no difference between a countrys real exchange rate and nominal exchange rate)Static expectationPerfect asset substitutabilityPerfect capital mobilityMarshall-Lerner condition holdsThe M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute4III

5、. Building Blocks of the ModelIII.1 The IS Schedule In an open economy, net export, should be taken into account when deriving the IS schedule. First, we simply assume a linear relation between private investment and the interest rate. Also we should recall the economic logics behind this simple ass

6、umption. Let I stand for private investment, and i, the nominal interest rate, I=I(i)=I0-bi, b0The M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute5 Second, recall also what we have learned in the course of Macroeconomics, C=C0+cYd, with Yd=Y-T, However, for simplicity,

7、 we neglect government transfer. Thus, C= C0+cY, with 0c1. And, G=G0 Finally, assuming,X-M=X0-M0-mY, 0m0 Where, P stands for domestic price which is supposed to be constant in a short term. When the money market is in equilibrium, Md/P=Ld(i,Y)=kY-hi=Ms/PThus, Y=1/k(hi+M/P) See Figure 8-2.The M-F Mod

8、el: A Graphical Illustration2022/8/14Chinese Finance Research Institute9Figure 8-2 LM schedule in an open economyiYLM2022/8/14Chinese Finance Research Institute10Differences of the LM curve in an open vs. a closed economy When using LM schedule in an open economy, great attention should be given to

9、considerations affecting the schedule. See the balance sheet of a central bank below. I strongly mend all of you surf the website of the Peoples Bank of China and try to understand the balance sheet of the Bank.The M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute11III.3

10、 The BP ScheduleIII.3.1 Analytical framework for the balance of paymentsApproach 1 Examining current account and capital and finance account separately, identifying determinations of each account, and taking both together into account. Approach 2 This approach does not distinguish the two account fr

11、om each other. The Monetary Approach to the Balance of Payment (MABP) is a typical representative.The M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute12III.3.2 Approach for analyzing international capital flow Approach 1 The approach views the interest rate as the most

12、important determinants affecting international capital flows. The method may be labeled as flow view which was quite popular in 1950s to early 1960s.Approach 2 The view holds that, in addition to the interest rate, risks and asset volumes also affect international capital flows. This may be called s

13、tock view, which refreshed in open economy macroeconomics ever since 1990s. The M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute13LowHigh18801860190019201940196019802000188019001914192918601925191819451960197119802000Bretton Woods(1945-1971)Interwar(1914-1945)Float(1971

14、-2000)Gold Standard(1880-1914)Figure 8-3-1 International capital flowSource: Obstfeld and Taylor (2001)2022/8/14Chinese Finance Research Institute14Figure 8-3-2 Gross international capital movementsPer cent of world GDP2022/8/14Chinese Finance Research Institute15Figure 8-3-3 Gross International cap

15、ital movementsPercent of world GDPBank and money market flows; portfolio and other debt-related flows;Portfolio equity flows; FDI2022/8/14Chinese Finance Research Institute16III.3 The BP schedule: A flow perspective Following the M-F model, We adopt flow view to analyze the role of international cap

16、ital flows in the balance of payments in an open economy. Let CA stand for the current balance, and K=K(i, i*) denote the capital account balance, and i* stand for the foreign interest rate. We have, BP=CA+K=X0-M0-mY+K(i, i*)=0 Specifically, we may define K(i, i*)=K(i)=K0+i, 0.The M-F Model: A Graph

17、ical Illustration2022/8/14Chinese Finance Research Institute17 Using the above BP equation, we may obtain the three types of BP schedule. See Figure 8-4. Be aware here also, the term FE, EE, and other designations may also be used in different textbooks or literature since there is no consensus upon

18、 the description of external equilibrium in an open economy.III.4 Factors Shifting the SchedulesIV. General Equilibrium in an Open Economy See Figure 8-5.The M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute18Figure 8-4 BP scheduleiYi*Perfect MobilityImperfect MobilityPe

19、rfect ImmobilityIncreasing Mobility=0= +(0, )2022/8/14Chinese Finance Research Institute19iYi*Y*ISLMBPBPFigure 8-5 General equilibrium2022/8/14Chinese Finance Research Institute20The M-F Model: A Graphical IllustrationV. Internal and External BalanceV.1 Policy ObjectiveInternal BalanceFull Employmen

20、tEconomic growthPrice-StabilizationExternal balance: A new objective The Optimal Level of the Current Account 2022/8/14Chinese Finance Research Institute21The M-F Model: A Graphical IllustrationV.2 Policy Instruments Expenditure changing policyFiscal policy Monetary policyExpenditure-switching polic

21、yExchange rate policy RegulationSterilized vs. non-sterilized intervention2022/8/14Chinese Finance Research Institute22The M-F Model: A Graphical IllustrationVI. Internal & External Balance under Fixed RegimeMonetary Policy (Figure 8-6)Fiscal Policy (Figure 8-6) Conclusion: By combining an expansion

22、ary fiscal policy with a contractionary monetary policy (though passively) the authorities can achieve both internal and external balance.VII. Internal & External Balance under Floating RegimeMonetary Policy (Figure 8-7-1)Fiscal Policy (Figure 8-7-2)2022/8/14Chinese Finance Research Institute23Figur

23、e 8-6 Internal and external balance under fixed regimeiYLM1IS1BPi1Y1IS2Y2i2ABLM2Ci3Yf2022/8/14Chinese Finance Research Institute24Figure 8-7-1 A monetary increase under floating regimeiYLM1IS1BP1i1Y1IS2Y2i2ACBBP2LM22022/8/14Chinese Finance Research Institute25Figure 8-7-2-1 A fiscal increase under f

24、loating regimeiYIS1BP1i1Y1IS2Y2i2ABBP2LM1IS32022/8/14Chinese Finance Research Institute26Figure 8-7-2-2 A fiscal increase under floating regimeiYLM1IS1BP1i1Y1IS2Y2i2ACBBP2IS32022/8/14Chinese Finance Research Institute27VII. A SOE with perfect capital mobilityVII.1 Fixed Exchange Rate RegimeMonetary

25、policy (Figure 8-8-1)Fiscal policy (Figure 8-8-2)Policy effectiveness As far as output growth is concerned, monetary policy is totally ineffective under a fixed rate regime, while an expansionary fiscal policy can lead to a larger increase of output than that under a floating rate economy. The M-F M

26、odel: A Graphical Illustration2022/8/14Chinese Finance Research Institute28Figure 8-8-1 Monetary policy in a fixed regimeiYi*Y1ISLMBPLMEB2022/8/14Chinese Finance Research Institute29Figure 8-8-2 Fiscal policy in a fixed regimeiYY1ISBPLMEBISLMEY2i*2022/8/14Chinese Finance Research Institute30VII.2 Fl

27、oating Exchange Rate RegimeMonetary policy (Figure 8-9-1)Fiscal policy (Figure 8-9-2)Policy effectivenessFiscal policy is totally ineffective under a floating rate regime, while monetary policy can lead to changes in output.A monetary expansion leads to a depreciation of home currency while an expan

28、sionary fiscal policy leads to the appreciation of home currencyThe M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute31Figure 8-9-1 Monetary policy in a floating regimeiYY1ISBPLMELMISEY2i*2022/8/14Chinese Finance Research Institute32Figure 8-9-2 Fiscal policy in a floati

29、ng regimeiYY1ISBPLMEISBi*2022/8/14Chinese Finance Research Institute33VII.3 A Brief Summarization See Table 8-1. Table 8-1 Policy Effectiveness under Different RegimesNote: 1. Effectiveness here refers to the impact of a policy upon output. 2. See also the lecture on “fixed exchange rates and foreig

30、n exchange intervention” for another explanation of the effectiveness of monetary and fiscal policies under a fixed rate.The M-F Model: A Graphical Illustration2022/8/14Chinese Finance Research Institute34The M-F Model: A Formal IllustrationI. The ModelI.1 Money Demandm-p=md-p=0y- 1i 1I.2 Goods Mark

31、ety=d=g+1(s-p)+2y-3i, 1, 30, 020; s/m=(1-2)/(01)0Fiscal policy effecty/g=0; s/g= -1/10; y/y*=?2022/8/14Chinese Finance Research Institute38II.2 Fixed Exchange Rate Regime Under such a case, the exchange rate, s, is assumed to be unchanged provided that the central bank could maintain its announced p

32、arity. To achieve the goal, the central bank is ready to be engaged in foreign exchange market intervention. The foreign reserve part of the central banks money base es an endogenous variable. Thus, m-p=0y- 1i* 1(1-2)y=g+1(s-p)-3i* 2 Rearranging and totally differentiating the system,The M-F Model:

33、A Formal Illustration2022/8/14Chinese Finance Research Institute39The M-F Model: A Formal Illustration0dy+(-1)dm= 0ds+0dg+1di* 1(1-2)dy+0dm=1ds+dg-3di* 2 Without loss of generality, define, m=c+r Where, c, and r are domestic credit and foreign reserve expressed in natural logarithm. Therefore, the s

34、ystem can be rewritten as follows, 0dy-dr-dc= 0ds+0dg+1di* (1-2)dy+0dr+0dc=1ds+dg-3di* 2022/8/14Chinese Finance Research Institute40The M-F Model: A Formal IllustrationIn matrix form, Moentary policy y/c=0; r/c=1Fiscal policy y/g=1/(1-2); r/g= 0/(1-2)0Devaluation and revaluation y/s= 1/(1-2); r/s= (

35、01)/(1-2)0 2022/8/14Chinese Finance Research Institute41An Overall Appraisal The Marshall-Lerner condition Negligence of supply-side factorsPrice stickinessTreatment of capital flowsInteraction of stocks and flowsNegligence of long-run budget constraintsWealth effects2022/8/14Chinese Finance Research Institute42Exchange rate expectationsFlexibility of policy instrumentsPerfect competition in the goods marketAd hoc specification of behavior fun