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One would have thought that the financial crisis would have served as a decisive empirical test, separating the wheat from the chaff. Instead, very few schools of thought have shifted their positions. Part of the reason is no doubt because, as Einstein once said, theory determines what we see (Salam 1990, p. 99). To illustrate this point while at t...
Contexts in source publication
Context 1
... M is the supply of money, V is the velocity of money, P is the price level, and y is real output. Since they see the money supply as exogenous and given at any point in time and V as constant due to the fact that the behavioral and institutional characteristics that determine it change very slowly, only P and y may vary in the absence of a policy change. Every aggregate demand curve is drawn for a particular constant V and given M, and shows every combination of P and y that, when multiplied, yield MV. This yields the aggregate demand, y d , curve shown in Were we considering a flexible exchange rate regime, this would complete the specification of the model. Figures 1 and 2 would be placed side by side and whenever a change in price occurred in the domestic macroeconomy (as a result of a shift in y d or y s ), this would cause a movement along the PPP curve and a change in the exchange rate. Take, for example, the situation illustrated in Figure 3. If we begin with y d and y s , then the macroeconomy is in equilibrium at P 0 and y 0 . If purchasing power parity holds and the foreign price level is represented by the slope of PPP, the exchange rate (domestic currency units per foreign currency units) must be S 0 . Now assume that the central bank raises the money supply, thereby shifting y d to y d ...
Context 2
... short, the rise in the money supply increases demand which leads to domestic price inflation, causing a trade deficit. As this means that domestic currency must be in excess supply, it depreciates until balanced trade is restored (FX is foreign currency): However, as Greece is not in a flexible exchange rate regime, at least not vis-a-vis those countries which were significant players in the debt crisis (in particular, Germany), we cannot use the model shown in Figure 3. It is necessary to add a third graph in order to take into account capital flows resulting from currency market intervention. This is shown in Figure 4. This new graph works in concert with the first two as follows. Taking Figure 5, say we start at all the points labeled A. On the PPP graph, this means we are at (P 0 , S 0 ) with balanced trade. Meanwhile, the domestic economy is at (P 0 , y 0 ) and full employment, and the total money supply is M 0 of which there is DC 0 domestic currency and FX 0 foreign. For simplicity, it is typically assumed that we have scaled the P and M vertical axes such that M 0 = P 0 . Now, just as in However, this is a fixed exchange rate regime and so S cannot adjust as it did earlier. It is stuck at S 0 , and what sticks it there is key. As domestic currency tries to depreciate relative to foreign in response to the excess supply created by the trade deficit, the central bank is required by the rules of the system to intervene and stop it from doing so. The only way to prevent this is to buy domestic currency (and thus neutralize the excess supply), which they do with their reserves of foreign exchange (note that the currency they purchase remains in the central bank's vaults and does not become part of DC). This means that the country starts losing FX, which falls and causes us to move down the new M = DC + FX curve. This process continues until there is no longer a trade deficit. In other words, it must continue until P is once again P 0 . Every penny of the initial increase in DC must be offset by an eventual fall in FX; meanwhile, P and y d return to their starting ...
Context 3
... setup will be similar to that in Figure 3, with the domestic economy represented by a graph on the right and the international in a second one to the left. The former is shown in Figure 7, which shows Keynes' Z-D diagram. As this model does not assume full employment, the determination of the current level becomes a key question. Hence, the horizontal axis shows employment (N) rather than real output. In addition, Keynes argued that because real-world business transactions are conducted in nominal terms, our models should reflect this. Thus, the vertical axis is the dollar value (Py) of total expenditures, income, or output in the macroeconomy (all of which must necessarily be equal in a closed ...
Context 4
... = (S, P, P*, y*) +, -, +, + m = (S, P, P*, y) -, +, -, + where x is real domestic exports, m is real domestic imports, S is the exchange rate (domestic currency units per foreign currency unit), P is the domestic price level, P* is the foreign price level, y is real domestic income, and y* is real foreign income. Essentially, anything that makes domestic goods relatively more expensive (9S, 8P, 9P*) lowers exports and raises imports, while increases in foreign income raise exports and increases in domestic income raise imports. Now take point A on Figure 8 and assume that, for given levels of y* and P*, this particular combination of Py and S yields balanced trade (x=m). If domestic prices were to rise as they did in the Monetary Model depicted in Figure 3, this would move us to a point above the BTFX (see point B). Just as in the Monetary Model, this leads to a trade deficit. Unlike the Monetary Model, however, we are already in equilibrium. This is so because there is no assumption that this leads to an excess supply of domestic currency, causing a depreciation and a rightward movement in S. If that did, indeed, occur, the trade imbalance would shrink and eventually disappear once we reached BTFX again at point C. 3 But the only reason that happened in the Monetary Model was because it was assumed that the sole reason agents demanded foreign currency was to buy foreign goods and services. Were that the case then, indeed, any time there was an excess demand for foreign goods and services (i.e., a trade deficit) this would by definition be equivalent to an excess demand for foreign currency. For ...
Context 5
... M is the supply of money, V is the velocity of money, P is the price level, and y is real output. Since they see the money supply as exogenous and given at any point in time and V as constant due to the fact that the behavioral and institutional characteristics that determine it change very slowly, only P and y may vary in the absence of a policy change. Every aggregate demand curve is drawn for a particular constant V and given M, and shows every combination of P and y that, when multiplied, yield MV. This yields the aggregate demand, y d , curve shown in Were we considering a flexible exchange rate regime, this would complete the specification of the model. Figures 1 and 2 would be placed side by side and whenever a change in price occurred in the domestic macroeconomy (as a result of a shift in y d or y s ), this would cause a movement along the PPP curve and a change in the exchange rate. Take, for example, the situation illustrated in Figure 3. If we begin with y d and y s , then the macroeconomy is in equilibrium at P 0 and y 0 . If purchasing power parity holds and the foreign price level is represented by the slope of PPP, the exchange rate (domestic currency units per foreign currency units) must be S 0 . Now assume that the central bank raises the money supply, thereby shifting y d to y d ...
Context 6
... short, the rise in the money supply increases demand which leads to domestic price inflation, causing a trade deficit. As this means that domestic currency must be in excess supply, it depreciates until balanced trade is restored (FX is foreign currency): However, as Greece is not in a flexible exchange rate regime, at least not vis-a-vis those countries which were significant players in the debt crisis (in particular, Germany), we cannot use the model shown in Figure 3. It is necessary to add a third graph in order to take into account capital flows resulting from currency market intervention. This is shown in Figure 4. This new graph works in concert with the first two as follows. Taking Figure 5, say we start at all the points labeled A. On the PPP graph, this means we are at (P 0 , S 0 ) with balanced trade. Meanwhile, the domestic economy is at (P 0 , y 0 ) and full employment, and the total money supply is M 0 of which there is DC 0 domestic currency and FX 0 foreign. For simplicity, it is typically assumed that we have scaled the P and M vertical axes such that M 0 = P 0 . Now, just as in However, this is a fixed exchange rate regime and so S cannot adjust as it did earlier. It is stuck at S 0 , and what sticks it there is key. As domestic currency tries to depreciate relative to foreign in response to the excess supply created by the trade deficit, the central bank is required by the rules of the system to intervene and stop it from doing so. The only way to prevent this is to buy domestic currency (and thus neutralize the excess supply), which they do with their reserves of foreign exchange (note that the currency they purchase remains in the central bank's vaults and does not become part of DC). This means that the country starts losing FX, which falls and causes us to move down the new M = DC + FX curve. This process continues until there is no longer a trade deficit. In other words, it must continue until P is once again P 0 . Every penny of the initial increase in DC must be offset by an eventual fall in FX; meanwhile, P and y d return to their starting ...
Context 7
... setup will be similar to that in Figure 3, with the domestic economy represented by a graph on the right and the international in a second one to the left. The former is shown in Figure 7, which shows Keynes' Z-D diagram. As this model does not assume full employment, the determination of the current level becomes a key question. Hence, the horizontal axis shows employment (N) rather than real output. In addition, Keynes argued that because real-world business transactions are conducted in nominal terms, our models should reflect this. Thus, the vertical axis is the dollar value (Py) of total expenditures, income, or output in the macroeconomy (all of which must necessarily be equal in a closed ...
Context 8
... = (S, P, P*, y*) +, -, +, + m = (S, P, P*, y) -, +, -, + where x is real domestic exports, m is real domestic imports, S is the exchange rate (domestic currency units per foreign currency unit), P is the domestic price level, P* is the foreign price level, y is real domestic income, and y* is real foreign income. Essentially, anything that makes domestic goods relatively more expensive (9S, 8P, 9P*) lowers exports and raises imports, while increases in foreign income raise exports and increases in domestic income raise imports. Now take point A on Figure 8 and assume that, for given levels of y* and P*, this particular combination of Py and S yields balanced trade (x=m). If domestic prices were to rise as they did in the Monetary Model depicted in Figure 3, this would move us to a point above the BTFX (see point B). Just as in the Monetary Model, this leads to a trade deficit. Unlike the Monetary Model, however, we are already in equilibrium. This is so because there is no assumption that this leads to an excess supply of domestic currency, causing a depreciation and a rightward movement in S. If that did, indeed, occur, the trade imbalance would shrink and eventually disappear once we reached BTFX again at point C. 3 But the only reason that happened in the Monetary Model was because it was assumed that the sole reason agents demanded foreign currency was to buy foreign goods and services. Were that the case then, indeed, any time there was an excess demand for foreign goods and services (i.e., a trade deficit) this would by definition be equivalent to an excess demand for foreign currency. For ...