【正文】 a floating rate. See Figure 323. See also Figure 312 (MF Model). III. Exchange Rate Policy: See Figure 324. 47 S Y Y0 S0 AA DD Figure 322 Moary Policy AA1 Rise in Ms S1 Y1 48 S Y Y0 S0 AA DD Figure 323 Fiscal Policy DD1 Expansionary fiscal policy S1 Y1 AA1 Y2 1 2 3 49 S Y Y0 S0 AA DD AA1 S1 Y1 Figure 324 Exchange Rate Policy Y increases, S is to decline. The central bank has to increase Ms 50 ?Balance of Payments Crises Up till now, we have assumed that actors in foreign exchange market believe that the central bank can keep the target exchange rate. However, central banks always fail to defend their target rates due to speculative attacks. This is called currency crisis or balance of payments crisis. In this section, we analyze the factors leading to the crisis using the theory we have learned. See Figure 325. Actually, theory on currency crisis consists of three generations of theoretical models, namely those put forward by Krugman (1979), Flood and Garber (1984), and Obstfeld (1986) etc., and others aiming at explaining what leads to the Asia crises. 51 ?Balance of Payments Crises Currency crisis: The expectation of a future devaluation causes a balance of payments crisis marked by a sharp fall in reserves and a rise in the home interest rate above the world interest rate. Similarly, an expected revaluation causes an abrupt rise in foreign reserves together with a fall in the home interest rate below the world rate (Krugman and Obstfeld, 2020). Also balance of payments crisis can be caused by a country’s inappropriate macroeconomic policies as the first generation model would suggest (Krugman, 1979). In the recent Asia crisis, twin crises, namely balance of payments crisis and banking crisis, are emphasized by the economists. See MacDonald (2020) chapter 12 for a detailed survey. 52 Figure 325 Balance of Payments Crisis i* 0 S0 L(Y, i*) 1? 1 M1/P M2/P 2 2? i*+(S1 S)/S i*+(S0 S)/S Expectation to depreciate i*+(S1 S)/S 53 ?Sterilized Intervention I. Ineffectiveness of Sterilized Intervention Money Supply in case of Sterilized Intervention Selfdefeating Sterilized Intervention Here, we take expansionary fiscal policy in a fixed rate as an example to illustrate this point. See Figure 323. An expansionary fiscal policy leads to output increase and inflation, which the central bank may try to avoid by sterilizing the increase in the money supply that its fiscal policy has induced. Perfect Asset Substitutability 54 ?Sterilized Intervention II. Foreign Exchange Market Equilibrium under Imperfect Asset Substitutability Risks and Foreign Exchange Market Equilibrium ?Demand Taking risks into account, it is reasonable to assume that an individual’s demand for interestbearing domestic currency assets (Bnd) increases when the interested they offer (i) rises relative to the domestic currency return on foreign currency assets (i*+(ses)). Bnd= Bnd(ii*(ses)) 55 ?Sterilized Intervention Demand=Bd(ii*+(ses)) =?Bnd(ii*(ses)) (n=1, 2, …,N) ?Supply Net supply equals the value of domestic currency government bonds held by the public, B, less the value of domestic currency assets held by the central bank, A. Supply=BA ?Equilibrium Definition: The risk premium, ?, is the expected return difference between domestic and foreign bonds. 56 ?Sterilized Intervention Conclusion ?=? (BA) The risk premium on domestic bonds rises when BA rises. This relation between the risk premium and the central bank’s domestic assets holdings allows the bank to affect the exchange rate through sterilized foreign exchange intervention. It also implies that official operations in domestic and foreign assets may differ in their assets market impacts (Krugman and Obstfeld, 2020, 508). See Figure 326 for a graphical illustration of the point. 57 Figure 326 Equilibrium Bd(?) ? Quantity of Domestic Bonds ?1 ?2 BA1 BA2 1 2 58 ?Sterilized Intervention III. Sterilized Intervention in case of Imperfect Asset Substitutability Conclusion: With imperfect asset substitutability, even sterilized purchases of foreign exchange cause the home currency to depreciate. Similarly, sterilized sales of foreign exchange cause the home currency to appreciate. A slight modification of our analysis shows that the central bank can also use sterilized intervention to hold the exchange rate fixed as it varies the money supply to achieve domestic objectives such as full employment (Krugman and Obstfeld, 2020, 510). See Figure 327. 59 i 0 S1 Ms/P S2 Figure 327 Sterilized Intervention 1 1? 2? Purchasing foreign assets, selling domestic assets i*+ses+?(BA1) i*+ses+?(BA2) 60 ?Assignments ?Read and review textbooks on money and banking to get more understanding of central bank balance sheet and open market operation (OMO). ?Refer to Jiang and Yang (2020) for more analyses on sterilized intervention, and signaling effects, where the portfolio approach is used to analyze the problem. ?Review chapter 17. 61 Contents ?MF Model ?Eternal Triangle ?Assignments 62 ?MF Model I. Introduction The model, a baseline model of international finance and open economy macroeconomics, was originally raised by Robert A. Mundell (1963。 External Balance Internal Balance ?Full Employment ?PriceStabilization External Balance: A New Objective The Optimal Level of the Current Account Macroeconomic Policy under the Gold Standard ?The external balance 83 The pricespecieflow mechanism The rule of the game: myth and reality ?The