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236 CHAPTER 8. THE MUNDELL-FLEMING MODELr(1)LM(2)r*FFy 0ISyFigure 8.5: Expansionary Þscal policy shifts IS curve out. Incipientcapital inßow generates an appreciation which shifts the IS curve backto its original position.version of crowding out. Recipients of government spending expand atthe expense of the traded goods sector.Interest rate shocks. An increase in the foreign interest rate leads to anincipient capital outßow and a depreciation given byds =[(λ(1 − γ) +σφ)/φδ]di ∗ > 0. The expenditure-switching effectof the depreciation causes the IS curve in Figure 8.6 to shift out. Theexpansionary effect of the depreciation more than offsets the contractionaryeffect of the higher interest rate resulting in an expansion ofoutput dy =(λ/φ)di ∗ > 0.<strong>International</strong> transmission effects. If the interest rate shock was causedby a contraction in foreign money, the expansion of domestic outputwouldbeassociatedwithacontractionofforeignoutputandmonetarypolicy shocks are negatively transmitted from one country to anotherunder ßexible exchange rates. Government spending, on the other handis positively transmitted. If the increase in the foreign interest rate wasprecipitated by an expansion of foreign government spending, we wouldobserve expansion in output both abroad and at home.
8.2. DORNBUSCH’S DYNAMIC MUNDELL—FLEMING MODEL237rLM(1)r*FF(2)y 0y 1ISyFigure 8.6: An increase in the world interest rate generates an incipientcapital outßow, leading to a depreciation and an outward shift in theIS curve.8.2 Dornbusch’s Dynamic Mundell—FlemingModelAs we saw in Chapter 3, the exchange rate in a free ßoat behaves muchlike stock prices. In particular, it exhibits more volatility than <strong>macroe</strong>conomicfundamentals such as the money supply and real GDP. Dornbusch[39] presents a dynamic version of the Mundell—Fleming modelthat explains excess exchange rate volatility in a deterministic perfectforesight setting. The key feature of the model is that the asset marketadjusts to shocks instantaneously while goods market adjustment takestime.The money market is continuously in equilibrium which is representedby the LM curve, restated here asm − p = φy − λi. (8.6)To allow for possible disequilibrium in the goods market, let y denoteactual output which is assumed to be Þxed, andy d denote the demandfor home output. The demand for domestic goods depends on the real
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To Shirley, Laurie, and Leslii
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CONTENTSvii11 Balance of Payments C
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2 CHAPTER 1. SOME INSTITUTIONAL BAC
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80 CHAPTER 3. THE MONETARY MODEL3.1
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82 CHAPTER 3. THE MONETARY MODEL604
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84 CHAPTER 3. THE MONETARY MODEL0 <
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86 CHAPTER 3. THE MONETARY MODELexc
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90 CHAPTER 3. THE MONETARY MODELThe
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92 CHAPTER 3. THE MONETARY MODEL=
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96 CHAPTER 3. THE MONETARY MODELTab
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102 CHAPTER 3. THE MONETARY MODELMo
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104 CHAPTER 3. THE MONETARY MODELwh
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106 CHAPTER 4. THE LUCAS MODEL(76)
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108 CHAPTER 4. THE LUCAS MODELsubje
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110 CHAPTER 4. THE LUCAS MODELeach
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112 CHAPTER 4. THE LUCAS MODELcompl
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114 CHAPTER 4. THE LUCAS MODELdenot
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116 CHAPTER 4. THE LUCAS MODELc yt
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118 CHAPTER 4. THE LUCAS MODELIn eq
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120 CHAPTER 4. THE LUCAS MODELn t =
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122 CHAPTER 4. THE LUCAS MODELRearr
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124 CHAPTER 4. THE LUCAS MODELTable
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126 CHAPTER 4. THE LUCAS MODEL4.5 C
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128 CHAPTER 4. THE LUCAS MODELTable
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130 CHAPTER 4. THE LUCAS MODELdisco
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132 CHAPTER 4. THE LUCAS MODEL1.02A
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134 CHAPTER 4. THE LUCAS MODELAppen
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136 CHAPTER 4. THE LUCAS MODELProbl
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138 CHAPTER 5. INTERNATIONAL REAL B
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162CHAPTER 6. FOREIGN EXCHANGE MARK
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286CHAPTER 9. THE NEW INTERNATIONAL
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308 CHAPTER 10. TARGET-ZONE MODELSa
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310 CHAPTER 10. TARGET-ZONE MODELSt
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312 CHAPTER 10. TARGET-ZONE MODELSC
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314 CHAPTER 10. TARGET-ZONE MODELSl
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316 CHAPTER 10. TARGET-ZONE MODELST
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318 CHAPTER 10. TARGET-ZONE MODELSa
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320 CHAPTER 10. TARGET-ZONE MODELSM
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322 CHAPTER 10. TARGET-ZONE MODELSt
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324 CHAPTER 10. TARGET-ZONE MODELS
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326 CHAPTER 10. TARGET-ZONE MODELS
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328 CHAPTER 11. BALANCE OF PAYMENTS
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358 AUTHOR INDEXFama, E.F., 161, 16
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Subject IndexAAbsorption, 16, 230AI
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362 SUBJECT INDEXEfficient capital
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364 SUBJECT INDEXMethod of undeterm
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366 SUBJECT INDEXRisk neutrality, 9
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368 SUBJECT INDEXImpulse response a
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