[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Internet Connection
FOREIGN EXCHANGE RATES
The Universal Currency Converter at www.xe.com/ucc/ enables
you to find out how much $1 is worth in any of more than seventy
other currencies, from the Algerian dinar to the Zambian
kwacha. Historical series on U.S. dollar exchange rates with
many countries are provided by the Federal Reserve at
www.federalreserve.gov/releases/H10/hist/.
included in the CPI. Because the CPI includes both domestically produced and
foreign-produced goods, it is affected by changes in the exchange rate.
If the dollar appreciates, the dollar prices of foreign goods will fall. Because the
CPI includes foreign consumer goods while the GDP price index does not, the CPI
will fall relative to the GDP index. When the dollar depreciates, the opposite will
occur: the CPI index will rise relative to the GDP index. Fluctuations in the exchange
rate are one reason for the differences in reported inflation rates, differences that
depend on which price index is used to measure inflation.
Comparing Monetary and Fiscal
Policies in the Open Economy
In today’s open economy, policymakers designing macroeconomic policies must take
into account the effects of the exchange rate. In a closed economy, expansionary
monetary policy has a short-run effect on aggregate expenditures through lower
interest rates and an increase in available credit, while expansionary fiscal policy
eventually crowds out private investment. In the open economy, we have already
seen how the effects of changes in exchange rates, and their impact on net exports,
come into play when we analyze macroeconomic policy. In an open economy, the
relative utility of monetary and fiscal policies changes—monetary policy becomes
more effective in the short run while fiscal policy becomes less so.
MONETARY POLICY WITH FLEXIBLE
EXCHANGE RATES
When discretionary monetary policy actions are undertaken, their impact on the
economy is reinforced by the exchange rate. Suppose the Fed decides to raise interest
rates in the United States. And suppose Japan, members of the European Economic
and Monetary Union, and other countries do not match the interest rate increase.
The higher yields on U.S. bonds make them more attractive to both foreign and U.S.
investors. The resulting demand for U.S. dollars leads the dollar to appreciate.
The dollar’s appreciation discourages exports and encourages imports. Thus,
monetary policy succeeds in dampening aggregate demand both through the
COMPARING MONETARY AND FISCAL POLICIES IN THE OPEN ECONOMY ∂ 785