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Understanding Expansionary Monetary Policy and Its Effects in Venezuela's Flexible Exchange Rate System

This analysis explores the implications of expansionary monetary policy in Venezuela, particularly focusing on its flexible exchange rate system and high capital mobility. It discusses how effective policies such as open market purchases, lowered discount rates, and reduced reserve ratios can stimulate investment and consumption while causing depreciation of the domestic currency. The interaction between capital account and current account effects highlights the self-reinforcing nature of policy changes. Overall, this study provides a comprehensive overview of macroeconomic dynamics in Venezuela in response to monetary expansions.

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Understanding Expansionary Monetary Policy and Its Effects in Venezuela's Flexible Exchange Rate System

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  1. Macroeconomics and the Monetary System Homework Problem: The Complete Model with Flexible Exchange Rates

  2. Expansionary Monetary Policy in Venezuela: Flexible Exchanges Rates, High Capital Mobility SHOCK: Expansionary Monetary Policy in Venezuela 2 Capital Account Effect 3 Current Account Effect 1 Monetary Expansion Foreign Exchange Market Money Market Goods Market 4 5 Ricciardi

  3. Expansionary Monetary Policy in Venezuela: Flexible Exchanges Rates, High Capital Mobility SHOCK: Expansionary Monetary Policy in Venezuela Money Market Ricciardi

  4. r Ms Ms ' r1 r2 Md(Y1) M/P Expansionary Monetary Policy in Venezuela: Flexible Exchanges Rates, High Capital Mobility SHOCK: Expansionary Monetary Policy in Venezuela • Central Bank: • Open Market Purchase • Decrease Discount Rate • Lower Required Reserve Ratio • Ms > Md • Invest Excess Money Balances • Buy Bonds, Increase Pb • Lower Interest Yields • Lower Interest Rates • Induce Capital Outflows • Increase Real Investment and Consumption Money Market Ricciardi

  5. Foreign Exchange Market Money Market Goods Market 1 Monetary Expansion r Ms Ms ' r1 r2 Md(Y1) M/P SHOCK: Expansionary Monetary Policy in Venezuela 2 Capital Account Effect Ricciardi

  6. 1 Monetary Expansion => AD => Y, P Foreign Exchange Market Money Market Goods Market P r Ms Ms ' AS r1 r2 AD Md(Y1) M/P Y Y1 Y2 • Increased Real Investment • AD > AS • Upward Pressure on Prices & Output • Relative Effects a ƒ of location on AS • Increased Y& P Deteriorates CAcct SHOCK: Expansionary Monetary Policy in Venezuela Ricciardi

  7. Foreign Exchange Market Money Market Goods Market P r Ms Ms ' AS r1 r2 AD Md(Y1) M/P Y Y1 Y2 3 Capital Account Effect SHOCK: Expansionary Monetary Policy in Venezuela 2 Current Account Effect 1 Monetary Expansion Ricciardi

  8. K Accnt: (-) ≠ D for $ Ø r => ≠ S of Bs ØNE => ≠ S of Bs, ≠D for $ C Accnt: (-) ≠ Y, ≠ P => Foreign Exchange Market Money Market Goods Market $ / Bs S S ' 1 2 D SHOCK:Expansionary Monetary Policy in Venezuela 1 Monetary Expansion Depreciation of Bs Bs / t Ricciardi

  9. K Accnt: (-) ≠ D for $ Ø r => ≠ S of Bs ØNE => ≠ S of Bs, ≠D for $ C Accnt: (-) ≠ Y, ≠ P => $ / Bs S S ' 1 2 D SHOCK:Expansionary Monetary Policy in Venezuela • Capital Outflow means flight from Bs to foreign exchange • Rising Y induces imports, dumping Bs, demand for Fx • Rising domestic P induces additional imports • Both the Current and Capital Account Effects of Monetary Policy changes are self-reinforcing • Expansionary Monetary policy produces a depreciation of the domestic currency • Falling NE reduce AD, but depreciating Bs increases NE, increasing AD Foreign Exchange Market Depreciation of Bs Bs / t Ricciardi

  10. ≠ Ms => ≠ AD => ≠ Y, ≠ P K Accnt: (-) ≠ D for $ Ø r => ≠ S of Bs ØNE => ≠ S of Bs, ≠D for $ C Accnt: (-) ≠ Y, ≠ P => r P $ / Bs S S ' 1 2 D M/P Y Bs / t 3 2 5 1 4 Shock: Central Bank of Venezuela conducts expansionary monetary policy Money Market Goods Market Foreign Exchange Market Ms Ms ' AS r1 r2 Depreciation of Bs Md(Y2) AD Md(Y1) Y1 Y2 ≠ Y => ≠ Md, choking off Ø r Depreciation of Bs => ≠ NE Ricciardi

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