°°° Interest-Rate Differentials political turmoil or expect el isk premium个 LM
6 Interest-Rate Differentials political turmoil or expect e↓ → risk premium ↑ Y e IS* LM*
°°° Interest-Rate Differentials Implication although it and l, the depreciation of the currency stimulates NX by a greater amount, so that aggregate Income/ output↑
7 Interest-Rate Differentials Implication: although i↑ and I ↓, the depreciation of the currency stimulates NX by a greater amount, so that aggregate income/output ↑
°°° Interest-Rate Differentials o However, such a boom does not occur Central bank will defend the currency 2. P for imports↑+MP↓ 3. Risk premium↑& D for money↑ simultaneously (M/P=L(r+e,Y
8 Interest-Rate Differentials However, such a boom does not occur! 1. Central bank will defend the currency 2. P for imports↑→ M/P↓ 3. Risk premium↑ & D for money↑ simultaneously (M/P = L (r*+θ,Y))
°°° Interest-Rate Differentials o Mexico 1994-95 Beginning of 1994: NAFTA Political situation Risk premium t under fixed ex-rate End of 1994: devaluation of peso Risk premium↑ further Stock market crashed Government hard to get new bonds issued
9 Interest-Rate Differentials Mexico 1994-95 Beginning of 1994: NAFTA Political situation Risk premium ↑ under fixed ex-rate End of 1994: devaluation of peso Risk premium ↑ further Stock market crashed Government hard to get new bonds issued