Imported Intermediate Goods, Foreign Price Increases, and Domestic Monetary Policy: The IS-LM Analysıs Revived

He be g, Ho s ; McCann, Ewen A icle Impo ed In e media e Goods, Fo eign P ice Inc eases, and Domes ic Mone a y Policy: The IS-LM Analysıs Re i ed Zei sch i ü Wi scha s- und Sozialwissenscha en (ZWS) - Vie eljah essch i de Gesellscha ü Wi scha s- und Sozialwissenscha en, Ve ein ü Socialpoli ik P o ided in Coope a ion wi h: Duncke & Humblo , Be lin Sugges ed Ci a ion: He be g, Ho s ; McCann, Ewen (1982) : Impo ed In e media e Goods, Fo eign P ice Inc eases, and Domes ic Mone a y Policy: The IS-LM Analysıs Re i ed, Zei sch i ü Wi scha s- und Sozialwissenscha en (ZWS) - Vie eljah essch i de Gesellscha ü Wi scha s- und Sozialwissenscha en, Ve ein ü Socialpoli ik, ISSN 0342-1783, Duncke & Humblo , Be lin, Vol. 102, Iss. 3, pp. 237-258, h ps://doi.o g/10.3790/schm.102.3.237 This Ve sion is a ailable a : h ps://hdl.handle.ne /10419/291520 S anda d-Nu zungsbedingungen: Die Dokumen e au EconS o dü en zu eigenen wissenscha lichen Zwecken und zum P i a geb auch gespeiche und kopie we den. 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I he documen s ha e been made a ailable unde an Open Con en Licence (especially C ea i e Commons Licences), you may exe cise u he usage igh s as speci ied in he indica ed licence. h ps://c ea i ecommons.o g/licenses/by/4.0/ lmpo ed In e media e Goods, Fo eign P ice Inc eases,and Domes ic Mone a y Policy: The IS-LM Analysis Re i ed* By Ho s He be g and Ewen McCann Un il ecen ly impo s o in e media e goods ha e been neglec ed in mone- a y (no in eal) ade heo y . This pape deals wi h he mac oeconomic con- sequences o such impo s. The basic analy ical ool is a sui ably modi ied Hicksian IS-LM diag am. I is shown ha ade in in e media e goods does ha e some pa icula implica ions ha do no a ise o he wise. I. In oduc ion Fo a nu obe o yea s he Fleming!Mundell (FM) modeP has been he co ne -s one o open economy mac oeconomics. 2 Thig model was based on a nu obe o simpli ying assump ions he main ones being: "To ocus a en ion on policies a ec ing he le el o employmen , we assume unemployed esou ces, cons an e u ns o scale, and ixed money wages; his means ha he supply o domes ic ou pu is elas ic and i s p ice le el cons an ."3 Mundell men ions h ee condi ions o a ixed domes ic p oduc p ice, and he e is s ill a ou h one: absence o impo ed in e media e goods ( aw ma e ials, semi- inished p oduc s e c.). The ecen oil-p ice c ises, howe e , ha e eminded us ha he ou h condi ion is un enable. In addi ion, since he wo ldwide upsu ge o in la ion a es money wages ha e become indexed in many coun ies and in o he s wage nego ia ions a e gea ed a p e en ing a all in eal wages. Hence, he assump ion o a ixed money wage should be abandoned. 4 In o he wo ds, he FM * The idea o his pape eme ged, i s scope and con en s we e discussed and he necessa y calcula ions comple ed while He be g isi ed he Depa - men o Economics, Uni e si y o Can e bu y, New Zealand, in Ap il 1981. The i s d a was w i en du ing his s ay a he Depa men o Economics, Facul y o Economics, Aus alian Na ional Uni e si y, in May/June 1981 . Fleming (1962), Mundell (1963). 2 C . Chacoliades (1978), chap . 17, Dombusch (1980), chap . 11, Dombusch & Fische (1978), chap s. 18, 19, Sohmen (1969), chap . V, Takayama ' (1972), chap s. 10, 11. (This Iis is a om exhaus i e.) 3 Mundell (1963), 476; ou emphasis. "' The wide use o expec a ion-augmen ed Philipps cu e indica es ha his condi ion is no Ionge gene ally accep ed. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 238 Ho s He be g and Ewen McCann model has o be app op ia ely modi ied i i is o emain a use ul analy ical de ice. In ecen yea s a nu obe o au ho s ha e s udied he consequences o o eign p ice inc eases and domes ic economic policy o an economy impo ing in e media e ogoods. The e a e, o example, pape s by B uno and Sachs (1979), Findlay and Rod iguez (1977), He be g (1976), (1980), (1981), He be g, Hesse and Schuseil (1982), Obs eld (1980) and Schmid (1976), (1980)5. These au ho s ha e co e ed impo an g ound and answe ed many ques ions a issue. Ou main eason o ne e heless w i ing ye ano he pape is o show ha he Hicksian IS-LM analysis can be easily adap ed o ake in o accoun in e media e impo s and he consequen a iabili y o domes ic p oduc p ices and o p o ide a simple me hod o de i ing qui e a nu obe o conclusions. This me hod is especially sui ed o handle di e en possible condi ions ela ed, o example, o he ype o ade balance eac ion o exchange a e changes o o he deg ee o wage indexa ion. Since Hicksian diag ams a e well-known and widely used in mac oeconomics hei adap ion we a e going o p opose should help o unde s and mo e easily how in e media e im- po s a ec he basic economic ela ionships and which implica ions his has o he wo king o he sys em. This pape is o ganized as ollows: In sec ion II we s a e ou assump- ions and de i e some •basic ela ionships. Sec ion III is de o ed o es ab- lishing he p ope ies o he equilib ium loci o he commodi y ma ke , he money ma ke and he balance o paymen s, i. e. he IS, LM and BK cu es. In he inal sec ion IV we p esen a g aphical analysis o he consequences o o eign p ice inc eases unde ixed o lexible exchange a es, o a de alua ion o he home cu ency, and o mone a y policy unde lexible exchange a es. (Wi h ega d o iscal policy c . He be g, Hesse and Schuseil (1982).) II. Assump ions and basic equa ions We shall s udy 'a wo-coun y wo ld wi h a small domes ic o home economy and a !a ge o eign economy. The domes ic economy p oduces a single, inal (composi e) commodi y ha can be consumed and in es ed a home o expo ed. The o eign economy p oduces wo mo e (com- 5 An app oach o explain domes ic p ice a iabili y wi hou in oducing in e media e goods has been ollowed by A gy and Salop (1979). They wo k wi h a p ice index ha depends on he p ices o domes ic and o eign con- sump ion goods and wi h a ying deg ees o money illusion on he pa o labou . OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 The IS-LM Analysis Re i ed 239 posi e) commodi ies, one o hem a adeable pu ely in e media e good, he o he one a non- adeable inal good ha is a non-pe ec subs i u e o he domes ic p oduc . This is a minimal s uc u e o a model o s udying he consequences o in e media e impo s . Assuming ha he o eign adeable com- modi y also se es inal pu poses does no change he conclusions mo e han ma ginally -c . He be g!Hesse/Schuseil (1982) . And, as •Sanyal and J ones (1982) ha e a :gued, almos e e y impo ed commodi y has a leas o be anspo ed and e ailed be o e i can be consumed. Mo eo e , aking he home economy o be he sole p oduce o one o he commodi ies is consis en wi h casual obse a ions (Swiss wa ches, Columbian co ee, Swedish s eel) and empi ical e idence -c ., e.g., Isa d (1977), Lipsey and K a is (1977). Wi h ega d o he home economy we make he ollowing assump- ions (A 1)- (A 9): (A 1) P oduc ion Func ion (I) Q = F (N , R) Q ou pu ne o dep ecia ion, N labou inpu , R inpu o he impo ed in e media e good (all in physical uni s). F is a neoclassical p oduc ion unc ion; i is especially linea homoge- neaus and s ic ly quasi-conca e. The elas ici y o subs i u ion, a. be ween N and R is non-nega i e and less han uni y. (A 2) Labou Supply and Wage Fo ma ion Labou supply is comple ely elas ic a he cu en nominal wage a e, W. This wage a e is indexed wi h espec o he p ice o he domes ic p oduc , P:6 (2) W = cx P, 0 ::::; Y. = cons 2: 0 <X will be called he deg ee o wage indexa ion . Ob iously, unde pe ec indexa ion (.x = 1) he eal wage a e W!P is cons an , unde no indexa ion (.x = 0) he nominal wage a e is cons an , while impe ec indexa ion (0 < .x < 1) implies ha W inc eases bu WIP alls as P goes up .7 (A 3) P ice Fo ma ion Domes ic p oduce s ma k-up hei minimum a iable cos s: 6 u deno es he ela i e change du/u. 7 In coun ies wi hou o mal wage indexa ion bu wi h ade unians ying o p e en eal wages o decline cx could be in e p e ed as he unions ' elas ici y o p ice expec a ions. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 240 Ho s He be g and Ewen McCann (3) P = (1 + x) (WN + Pn R) I Q, x = cons 2:: 0 Pn domes ic cu ency p ice o he impo ed inpu These h ee assump ions de ine he domes ic agg ega e supply unc- ion, he impo unc ion and he eal income/ou pu ela ionship. They will be de i ed in u n. Agg ega e Supply Func ion This unc ion desc ibes he ela ionship be ween he domes ic supply p ice P, he ou pu le el Q and he domes ic p ice Pn o he in- e media e good. De ine:e (4) (5) AN : = WN/(WN + Pn R) cos sha e o labou eu : = Pn R/(WN + Pn R) = 1 - eN cos sha e o he impo ed inpu !?N : = E (Q, N) en : = E (Q, R) ou pu elas ici y wi h espec o labou ou pu elas ici y wi h espec o he impo ed inpu Bo h (}; a e posi i e and because o he linea homogenei y o F hey add up o uni y. Cos minimiza ion equi es W!Pn= aFJaN aFJaR Hence, eN = (}N, en = (}R· F om (2)- (4) (6) Mo eo e , eq. (1) and he de ini ion o a, e. and (!R imply: Q = ~N N + Qn R = 9N N + en R. R -N = (1 (W - Pn) The e o e, (7) Finally, inse ing (7) in o (6) we ind: (8) } > 0 gene ally 17 : = E (P, Pn) = en/(1 - e eN) ;;;; 1 o e $ 1 e E (u, ) deno es he (pa ial) elas ici y o u wi h espec o . OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 The IS-LM Analysis Re i ed 241 (9) E(P, Q) = 0 The las wo equa ions imply (i) ha o gi en Pn he domes ic supply cu e is ho izon al, (ii) ha a, say, one-pe cen inc ease in Pn shi s he cu e upwa ds by 17 pe cen and causes he domes ic e ms o ade P/Pn o de e io a e by 1 - 17 pe cen . Impo Func ion Real impo s, de ined as M = Pn R/P, a e de e mined by he ou pu Ie el and he domes ic p ice o he in e media e good: M = M (Pn, Q). The pa ial elas ici ies o his unc ion can be de i ed om ... - .... .... ... - M = Pn + R -P, W = a: P and eqs. (7)- (9): (10) (11) .p,: = E (M, Pn) = (1 - ~X) (1 - 1J) ~ 0 o a ~ 1 E (M, Q) = 1 We ecall ha o a: = 1 a change in Pn lea es Pn/P and Pn/W un- a ec ed. Since he e is hen no inpu subs i u ion R emains cons an and p, equals ze o. Fo a: < 1, howe e , Pn/P and Pn/W inc ease as Pn goes up. Subs i u ion Ieads o a all in R bu because o a < 1 his is p opo ionally smalle han he ise in Pn/P. Hence, p, is posi i e. Mo eo e , since he p oduc ion unc ion is linea homogeneaus in N and R and since P is independen o Q i ollows ha R and M change by he same pe cen age as Q, i. e. eq. (11) holds. Reallncome/Ou pu Rela ionship I is impo an , hough i ial, o obse e _!ha he home economy's nominal alue-added, i.e. i s nominal income, Y, alls sho o he ou pu alue, PQ, by he alue o in e media e impo s, Pn R. De ining eal income Y as YIP we he e o e ha e: Y = Q -M = (1 - m) Q wi h m = MIQ < 1 Real income is hus also a unc ion o ou pu and he domes ic p ice o he impo ed inpu : Y = Y (Pn, Q). Mo e speci ically, (12) dY = (1 - m) dQ -M ,u Pn . (A 4) Domes ic Abso p ion Domes ic eal abso p ion A depends on eal income and on he in- e es a e : 9 Ay deno es he pa ial de i a i e a A/a Y, and A, e c. is simila ly de ined. 16 Zei sch i ü Wi scha s- und Sozialwissenscha en 1982/3 OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 242 Ho s He be g and Ewen McCann (13) A = A (Y, ) , 0 < Ay < 1, A , < 0 (A 5) Expo s Real expo s X a e a unc ion o he a io P/P * o he domes ic supply p ice and he domes ic p ice o he o eign impo -compe ing commodi y : (14) X = X (P/P ''), - oo < ~ = E (X, P/P*) < 0 (A 6) Money Demand and Supply Real money demand L depends on ou pu and he in e es a e: (15) L = L (Q, ), 0 < E (L, Q) < 1, L, < 0 Ou pu has been aken as a de e minan o eal money demand since i s alue PQ seems obe a be e p oxy o he o al olume o ansac- ions han nominal income PY . Nominal money supply H has wo sou ces: Domes ic c edi c ea ion (Hd) and o eign ese e ansac ions by he domes ic cen al bank (H ) : (16) H = Hd + H , H = z Z nominal balance o paymen s, H ime de i a i e o H (A 7) Ne Capi al Impo s Nominal ne capi al impo s in e ms o domes ic cu ency, K, depend on he in e na ional in e es di e en ial. Wi h he o eign in- e es a e gi en and exchange a e expec a ions being s a ic: (17) K = K ( ), 0 ::::; K' ::::; oo (A 8) Domes i c/Fo eign P ice Rela ionships The e a e no a i s, anspo cos s o o he ade impedimen s : (18) e exchange a e (domes ic cu ency p ice o a o eign cu ency uni ), lln , ll* p ices o he wo o eign goods in e ms o o eign cu ency . As men ioned ea lie , we a e especially in e es ed in he con- sequences o inc eases in he p ice o he in e media e commodi y. The e o e, we shall ake he p ice o he o he o eign good, ll*, o emain cons an , and wi hou loss we no malize i o uni y . Le us summa ize. The home economy is desc ibed by he ollowing 5 equa ions: OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 supply unc ion: (19) The 15-LM Analysis Re i ed P = P(elln> eal income/ou pu ela ionship: (20) Y = Q- M (e IIn. Q) commodi y ma ke equilib ium: (21) Q = A (Y, ) + X (P/e) money ma ke equilib ium: (22) PL (Q, ) = H, H = Hd + H , H = Z balance o paymen s: (23) Z = P [X (P/e) -- M (e IIR, Q)] + K ( ) 111. P ope ies o he IS, LM and BK cu es 243 The g aphical analysis will be based on a sui able adap ion o he Hicksian diag am in (Y, )-space. Ob iously, we could also use simila diag ams in (Q, )-space o like A gy and Salop (1979) in (Y, P)-space bu hen he implica ions o ou model would no s and ou as clea ly agains hose o he FM model. Th ee equilib ium loci a e o impo ance. They a e de ined now as ollows: IS cu e: commodi y ma ke equilib ium (eq. (21)), LM cu e: money ma ke equilib ium (eq. (22)), BK cu e: balance-o -paymen s equilib ium (eq. (23) wi h Z = 0), each subjec o he agg ega e supply unc ion (eq. (19)) and he eal income/ou pu ela ionship (eq. (20)). To es ablish he p ope ies o hese loci we i s o m he o al di - e en ials o he las 5 equa ions: 0 0 1 -(1-m) -Ay 1 0 LQ 0 m (24) 0 0 17 0 0 - Mp, A, 0 0 - L, 1 0 K'!P 0 - Mp, 16° 1 0 -x; L -X;-X+M 17 -M~A- -x; 0 -x;-Mp, d dH lln e OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 244 Ho s He be g and Ewen McCann 1. IS Cu e Sol ing he i s h ee equa ions o (24) o dY yields: (25) [1- (1-m) Ay] dY =(1-m) A d + [(1-m) 17 x ~- M !~l Jjn + e wi h (26) T : = - (1 - m) (1 - 1]) X~ -M = -- (1 - 1J) [(1 - m) X~ + (1 -a) M] The coe icien o dY is posi i e and hose o d and IlR a e nega i e while may be o ei he sign. The e o e, (27a) 8Y/8 <o: nega i e slope (27b) 8Y/8 lln <o: le wa d shi i d ll R > 0 i T>O: igh wa d shi ) l de>O (27c) 8 Y/8 e = 0 i =O, especially ("( = 1: no shi <o i <o: le wa d shi Clea ly, T should be ela ed o he Ma shall-Le ne (ML) condi ion, and i is easy o see ha his is indeed he case. F om (8)- (11), (28) dX = X; (P - &) == - (1 - 1J) X~ , dM = MQ + M 1-' e As he ML condi ion usually equi es eal income o be s ill un- changed we impose his es ic ion he e as weil. (12) implies ha hen Q = m -1- e/(1 -m), and inse ing his equa ion in o (28) yields: (29) dX- dM J = e/(1- m> Y = cons Hence, he LM condi ion is sa is ied i > 0 and is s ic ly iola ed i <o. I is impo an o no e ha is ela ed o he change in he eal ade balance ollowing an exchange a e change wi h he p ice o he domes ic p oduc adjus ing. The e o e, mus be ze o i wages a e pe ec ly indexed since hen a a ia ion in e lea es eal expo s and eal impo s una ec ed. This is indeed bo ne ou by he RHS o he de ini ion O T ( emembe ha IX = 1 implies 'YJ = 1). In he FM model he ML condi ion is necessa y and su icien o s abili y. This is no Ionge ue o he p esen model, and hence we may, and will, s udy he consequences o < 0. The las obse a ion is o some impo ance o a leas wo easons: OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 IS / The 15-LM Analysis Re i ed / LM' / / LM" / 4._--"?,c...._/ --/ /_:_---w./ LM BK ~~~---------------------------------------------.Y Fig . 4 251 he home cu ency and some educ ion in he inc ease o PR and P and he dec ease o HIP. Allowing o he now mos a ou able ci cum- s ances, iz. < 0 and B < 0, no only he LM cu e bu also he IS and BK cu es mo e back o he igh o posi ions LM", IS" and BK". The new equilib ium a poin V is associa ed wi h a highe domes ic p oduc p ice and lowe le els o eal income and ou pu bu hese changes a e smalle han unde ixed exchange a es in he sho un as weil as in he quasi-lang un. To p o e ha he las conclusion is gene ally alid we ha e o show ha all h ee cu es mus inally lie o he le o hei ini ial posi ions. Suppose o he momen he exchange a e had allen o such an ex en ha -e = iiR and hence PR = p = 0. Then he new equilib ium seems obe associa ed wi h he old le els o Y, Q, e c. Howe e , he ela i e p ice Pie o he domes ic p oduc , ele an o o eigne s, has L"isen, so ha eal expo s ha e declined. Since his would imply a paymen s de ici he exchange a e can in ac no all as much as jus assumed. To pu i di e en ly, -e > llR, PR> 0 and P > 0 mus al- OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 252 Ho s He be g and Ewen McCann ways hold. Consequen ly, IS", LM" and BK" a e indeed posi ioned o he le o IS, LM and BK, espec i ely. Clea ly, > 0 and B > 0 ce e is pa ibus now imply a mo e p o- nounced all in Y and Q han in he p e ious case when he e was a de alua ion. Thus we ha e a second esul : Suppose again domes ic commodi y supply is comple ely elas ic. Exchange a es lexibili y hen does no p e en a ise o he o eign p ice o he impo ed inpu o cause in la ion-cum- ecession a home. In ac , as he ex e nal alue o he domes ic cu ency need no inc ease bu may decline hese ad e se e ec s can e en be s onge han unde pegged exchange a es. Mos o ou a gumen s did no depend an he deg ee o wage in- dexa ion. The only excep ion is ha some o he seconda y changes in case o a de alua ion canno occu i <X = 1 since hen = 0. Bu ha is o mino consequence. The e o e, he wo esul s epo ed abo e a e alid o 0 < <X < 1. I should be aken in o accoun ha in eali y coun ies impo a whole a ay o in e media e goods. I he o eign p ice o one o hem, e en i i is an impo an aw ma e ial like c ude oil, goes up i will aise domes ic p oduc p ices only by a smalle pe cen age al hough wages may be ully indexed . The eason is ha some inpu cos s emain he same. As a simila " e a da ion e ec " ollows om less- han- ull wage indexa ion, we should in he p esen case ake <X o be less han uni y. A he same ime i is emp ing o look in o he ques ion how he ex en o which cu es shi and he e o e equilib ia change a ies wi h he deg ee o indexa ion. This would equi e o s udy he ela ionships c he a ious coe icien s in eqs. (26), (30) and (32) an he one hand and a an he o he hand . A quick inspec ion, howe e , e eals ha one can- no hope o sweeping, clea -cu indings. So a we ha e no discussed changes in employmen . l will be e- called ha , unlike he FM assump ions, ou assump ions da no imply ha ou pu and employmen , Je alone eal income and employmen , always change in he same di ec ion. The eason, o cou se, is he p esence o subs i u ion e ec s in p oduc ion. Bu hese e ec s a e small i o is close o ze o so ha he wo inpu s a e poo subs i u es o i <X is close o uni y so ha he inpu -p ice a io does no change much, and hey a e nil o o = 0 o <X = 1. Ou hi d esul is: Highe cos s o he impo ed inpu educe employ- men unde bo h exchange a e egimes i he elas ici y o inpu sub- OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 The IS-LM Analysis Re i ed 253 s i u ion is nil o small o i wages a e (nea ly) pe ec ly indexed . O he wise employmen may inc ease al hough ou pu and eal income decline. Tha highe p ices o impo ed inpu s will ha e a s ag la iona y impac an he domes ic economy has o me ly been shown by B uno and Sachs (1979), Findlay and Rod iguez (1977), He be g (1980), (1981) and Schmid (1980). He be g and Schmid also obse ed ha exchange a e lexibili y may wo sen he si ua ion, and He be g has s udied he implica ions o he deg ee o wage indexa ion. 2. De alua ion o • he Home Cu ency lmplici ly, he consequences o a de alua ion o he ha ne cu ency ha e al eady been deal wi h in he p e ious subsec ion. As we ha e seen, an inc ease o he exchange a e need no , as in he FM wo ld, aise eal income and ou pu , and ha o wo easons: (i) The ade balance may de e io a e (F < 0). (ii) The compe i i eness o domes ic p oduce s need no imp o e (cx = 1) 11 • Figu e 2 can be ein e p e ed o co e he i s o hese possibili ies. The ansi ion om IS, LM, BK o IS', LM', BK' is now due o he de alua ion. The new sho - un equilib ium a U is associa ed wi h lowe eal income and ou pu and wi h a highe domes ic p oduc p ice. As discussed in no e 10, s aibili y equi es ha he balance o paymen s has u ned in o su plus, i.e. ha U lies o he le o BK' . Hence, nominal money supply inc eases and pa ly, bu no comple ely, e- e ses he decline in Y and Q. Only i in ime o eign impo demand becomes su icien ly elas ic o ende he LM condi ion sa is ied he de alua ion will inally esul in an expansion. Conside he second case and, o highligh he implica ions o pe - ec wage indexa ion, suppose ha ade was ini ially balanced . Fig- u e 5 applies. An inc ease o he exchange a e shi s he LM cu e o he le o posi ion LM'. Since = 0 he IS cu e emains una ec ed. Mo eo e , since poin s an he BK cu e o he uppe igh (lowe le ) o T a e associa ed wi h a ade de ici (su plus), his cu e o a es coun e -clockwise a aund T. The sho - un e ec o a de alua ion is again a all in eal income and ou pu (c . poin U). The balance-o - paymen s induced inc ease in nominal money supply, howe e , shi s he LM cu e back un il i once mo e passes h ough T. Hence, a de al- 11 In he p esen case "' = I is no subjec o he same objec ions as dis- cussed abo e wi h ega d o changes in Il R since a de alua ion a ec s he domes ic p ices o all impo ed in e media e goods. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 254 Ho s He be g and Ewen McCann T I ~~~-------------------------------------------.Y Fig. 5 ua ion has no pe manen eal e ec s; i only aises he domes ic p o- duc p ice by he same pe cen age by which he exchange a e has gone up . Thus we ha e a ou h esul : Unde pe ec wage indexa ion a de al- ua ion o he home cu ency has an ad e se ansi o y, bu no pe - manen impac on eal income, ou pu and employmen . I , howe e , he ML condi ion is s ic ly iola ed, he same policy is ecessiona y in he sho un as well as in he quasi-long un. Finally we obse e ha e en i a de alua ion does wo k as expec ed i s expansiona y e ec is he weake he la ge cx. This is due o he ac ha a highe deg ee o wage indexa ion means, ce e is pa ibus, mo e p onounced domes ic p ice inc eases which e ode pa o he possible imp o emen o he home p oduce s' compe i i eness. 3. Mone a y Policy The consequences o mone a y policy ha e also implici ly been de i ed in subsec ion IV 1. We ha e seen he e ha unde ixed ex- change a es i s e ec s a e quali a i ely he same as in he FM model. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 The IS-LM Analysis Re i ed 255 Fig.6 Unde lexible a es, howe e , hey can be d as ically di e en , and his is, o cou se, due o he conco ni an exchange a e changes. To suppo he s a emen le us look in o he same wo special cases as abo e: The basic ea u e is ha a highe nominal money supply causes a de alua ion o he home cu ency. Figu es 6 and 7 shown he com- bined implica ions o hese changes o < 0 o o IX = 1, B = 0, espec i ely. ' lhis es ablishes a i h ' and inal esul : Le exchange a es be lexi- ble. Unde pe ec wage indexa ion and wi h ade ini ially balanced an inc ease in nominal money supply aises he domes ic p oduc p ice by he same pe cen age and lea es eal income, ou pu and employmen comple ely una ec ed. I , on he o he hand, he ML condi ion is s ic ly iola ed he same policy leads o an e en highe p ice inc ease and o a decline in eal income e c. These ou comes a e independen o he deg ee o in e na ional capi al mobili y. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 256 Ho s He be g and Ewen McCann LM / / I / I y Fig.7 Ob iously , hese indings a e alien o a FM wo ld, and hey shed some new ligh on he old ques ion o he e icacy o mone a y policy12• The secend one has also been epo ed, al hough based on qui e di - e en easoning, by Niehans (1975). And he i s one is a a he com- mon conclusion, a leas wi h ega d o he "lang un", o he mone a y app oach o he balance o paymen s (c ., e.g., Do nbusch (1980), chap . 11/11) and e e ences gi en he e) . Bu i will be no ed ha i has been de i ed he e wi hou elying on he concep o a ull employ- men le el o income o a na u al a e o unemploymen om which he ha ne economy can a mos empo a ily de ia e. Ins ead i ollows om he ac ha , al hough nominal money supply and absolu e p ices ise, eal money supply and ela i e p ices emain unchanged . ! He be g, Hesse and Schuseil (1982) ha e shown ha on he o he band unde lexible exchange a es and pe ec wage indexa ion iscal policy ends o be he mo e e ec i e he highe he deg ee o in e na ional capi al mobili y. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 The IS-LM Analysis Re i ed 257 4. Some Ex ensions Close inspec ion e eals ha he undamen al condi ion o he las wo indings is an in e se ela ionship be ween he exchange a e and eal money supply. Such a ela ionship would also exis in he absence o impo ed in e media e goods, bu wi h he domes ic p ice le el in- co po a ing o eign consump ion goods and wi h wage indexa ion . Con- sequen ly, simila esul s apply. Mo eo e , we wish o epo ha all ou indings ca y o e o he case o declining labou p oduc i i y and hence an upwa d sloping domes ic supply cu e since he IS, LM and BK cu es e ain hei basic p ope ies. (Fo a de ailed p oo in e es ed eade s should con ac he au ho s.) Summa y Allowing o impo s o in e media e goods and o wage indexa ion o a ious deg ees he pape deals wi h he mac oeconomic consequences o o eign p ice inc eases, a de alua ion o he home cu ency o an expansiona y domes ic mone a y policy o a small open economy. Based on sui ably modi ied Hicksian IS-LM diag ams he analysis yields a nu obe o clea -cu esul s ha pa ly di e om he implica ions o he Fleming- Mundell model. E. g., highe p ices o impo ed inpu s can be expec ed o cause in la ion-cum- ecession a home and he same migh e en be ue o an inc ease o domes ic money supply. Zusammen assung In diese A bei we den ü eine kleine o ene Volkswi scha , die Zwi- schenp oduk e impo ie und in de de Nominallohnsa z ollkommen ode eilweise indexie is , die mak oökonomischen Auswi kungen auslän- dische P eiss eige ungen, eine Abwe ung de heimischen Wäh ung ode eine expansi en inländischen Geldpoli ik un e such . G undlage de Ana- lyse is ein geeigne modi izie es Hicks'sches IS-LM-Diag amm. Es wi d eine Reihe kla e E gebnisse abgelei e , die z. T. on den Implika ionen des Fleming-Mundell-Modells abweichen. Beispielsweise we den s eigende Ko- s en ü impo ie e Inpu s in de Regel zu In la ion und Rezension üh en, und gleiches kann soga die Folge eine Auswei ung de inländischen Geld- menge sein. He e ences A gy, V. and J. Salop (1979), P ice and ou pu e ec s o mone a y and iscal policy unde lexible exchange a es. IMF S a Pape s 26 (1979), 224- 256. B uno , M. and J. Sachs (1979), Mac oeconomic adjus men wi h impo p ice shocks: Real and mone a y aspec s, Ins i u e o In e na ional Economic S udies, Discussion Pape 118. S ockholm. 1'1 Zel sch i li Wi scha s- und Sozialwissenscha en 1982 /3 OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15 258 Ho s He be g and Ewen McCann Chacoliades, M. (1978), In e na ional mone a y heo y and policy . New Yo k. Do nbusch, R. (1980), Open economy mac oeconomics. New Yo k . - and S. Fische (1978), Mac oeconomics. New Yo k . Findlay, R. and C. A. Rod iguez (1977), In e media e impo s and mac oeco- nomic policy unde lexible exchange a es . Canadian Jou nal o Eco- nomics 10 (1977), 208-217. Fleming , J. M. (1962), Domes ic inancial policies unde ixed and lexible exchange a es. IMF S a Pape s 9 (1962), 369- 380; ep in ed in: J . M. Fleming, Essays in in e na ional economics. London (1979). He be g, H. (1976), On impo ed in la ion. Zei sch i ü die gesam e S aa s- wissenscha 132 (1976), 609- 632. -(1980), lmpo ed i n e media e goods, o eign p ice inc eases, and domes ic economic policy. Ins i u ü Theo e ische Volkswi scha sleh e, Uni e - si ä Kiel (mimeo .). -(1981), Impo ie e Zwischenp oduk e und mone ä e Außenhandels heo ie, in : G. Bombach, B. Gahlen , A. E. O (eds.), Zu Theo ie und Poli ik in e na ionale Wi scha sbeziehungen . Tübingen , 215 -264. -, H. Hesse and A. Schuseil (1982), Impo s o in e media e goods and he e icacy o iscal policy unde lexible exchange a es . Wel wi scha liches A chi 118 (1982), 104 -130. Isa d , P. (1977), How a can we push he "law o one p ice". Ame ican Eco- nomic Re iew 67 (1977), 942 -948. K a is, I. B. and R. E. Lipsey (1977), Expo p ices and he ansmission o in la ion . Ame ican Econom ic Re iew 67 (1977), 155 -163. Mundell , R. A. (1963), Capi al mobili y and s abiliza ion policy unde ixed and lexible exchange a es . Canadian Jou nal o Economics and Poli ical Science 29 (1963), 475-485, ep in ed in : R. A. Mundell, In e na ional Eco- nomics. London (1968). Niehans, J. (1975), Some doub s abou he e iciacy o mone a y policy unde lexible exchange a es. Jou nal o In e na ional Economics 5 (1975), 275-281. Obs eld, M. (1980), In e media e impo s, he e ms o ade, and he dynamics o he exchange a e and cu en accoun . Jou nal o In e - na ional Economics 10 (1980), 461 -480. Sanyal, K. K. and R. W. Jones (1982), The heo y o adein middle p oduc s . Ame ican Economic Re iew 72 (1982), 16- 31. Schmid, M. (1976), A model o ade in money, goods and ac o s . Jou nal o In e na ional Economics 6 (1976), 347- 361. -(1980), Ressou cenimpo , P eisni eau und Beschä igung, in: H. Siebe (ed.), E schöp ba e Ressou cen. Sch i en des Ve eins ü Socialpoli ik N. F. 108. (1980), Be lin, 667- 706. Sohmen , E. (1969), Flexible exchange a es , e . ed. Chicago- London. Takayama, A. (1972), In e na ional ade : An app oach o he heo y . New Yo k . OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/schm.102.3.237 | Gene a ed on 2023-04-04 12:01:15