Transcript Output and Exchange Rate in the Short Run

Topic 10
Output and the
Exchange Rate
in the Short Run
Slides prepared by Thomas Bishop
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• Determinants of aggregate demand in the short run
• A short run model of output markets
• A short run model of asset markets
• A short run model for both output markets and asset
markets
• Effects of temporary and permanent changes in
monetary and fiscal policies
• Adjustment of the current account over time
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16-2
Introduction
• Previously, we examined the linkages between
exchange rates, interest rates, and price levels but
always assumed that output levels were determined
outside the model.
• Here we complete our picture of the economy by
including how output and the exchange rate are
determined in the SR.
 Present a theory of how output adjusts to demand changes
when prices are slow to adjust.
 It shows how macroeconomic policies can affect production,
employment, and the current account.
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16-3
Introduction (cont.)
• The LR exchange rate model (of the previous lecture)
provides the framework that asset market participants
use to form their expectations about future exchange
rates.
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16-4
Determinants of Aggregate Demand
•
Aggregate demand is the amount of goods
and services that individuals and institutions
are willing to buy. It is the sum of:
1.
2.
3.
4.
consumption expenditure (C)
investment expenditure (I)
government purchases (G)
net expenditures by foreigners (EX-IM): the
current account (CA)
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16-5
Determinants of Aggregate Demand
(cont.)
• Determinants of C include:
 Disposable income (Yd): income from production
(Y) minus taxes (T).
 More Yd means more C, but C typically increases
less than the amount that Yd increases because
part of Yd is saved.
 Real interest rates may influence the amount of
saving and thereby C, but we assume that they are
relatively unimportant here.
 Wealth may also influence C, but we assume that it
is relatively unimportant here.
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16-6
Determinants of Aggregate Demand
(cont.)
• Determinants of the CA include:
 Real exchange rate: prices of foreign products
relative to the prices of domestic products, both
measured in domestic currency: EP*/P
 As the prices of foreign products rise relative to those of
domestic products, expenditure on domestic products
rises, and expenditure on foreign products falls.
 Disposable income: more disposable income
means more expenditure on foreign products
(imports)
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16-7
How Real Exchange Rate Changes Affect
the Current Account
•
The CA measures the value of exports relative to the
value of imports: CA ≈ EX – IM.

When the real exchange rate EP*/P rises, the prices
of foreign products rise relative to the prices of
domestic products.
1. The volume of exports that are bought by foreigners rises.
2. The volume of imports that are bought by domestic
residents falls.
3. The value of imports in terms of domestic products rises:
the value/price of imports rises, since foreign products are
more valuable/expensive.
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16-8
How Real Exchange Rate Changes Affect
the Current Account (cont.)
• If the volumes of imports and exports do not change
much, the value effect may dominate the volume
effect when the real exchange rate changes.
 E.g., contract obligations to buy fixed amounts of products
may cause the volume effect to be small.
• However, evidence indicates that for most countries
the volume effect dominates the value effect after one
year or less.
 Import and export demands tend to be relatively elastic.
• Let’s assume for now that a real depreciation leads to
an increase in the CA: the volume effect dominates
the value effect.
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16-9
Determinants of Aggregate Demand
• Determinants of the CA include:
 Real exchange rate: an increase in the real
exchange rate (i.e., ↑EP*/P) increases the CA.
 Disposable income: an increase in disposable
income decreases the CA.
• Note: an ↑Yd does not affect export demand because we
are holding foreign income constant and not allowing Yd
to affect it.
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16-10
Determinants of Aggregate Demand
(cont.)
• For simplicity, we assume that exogenous political
factors determine government purchases (G) and the
level of taxes (T).
• For simplicity, we assume that investment expenditure
(I) is determined by exogenous business decisions.
 More complicated models show that I depends on the cost of
borrowing to finance investment: the interest rate.
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16-11
Determinants of Aggregate Demand
(cont.)
• Aggregate demand is therefore expressed as:
D = C(Y – T) + I + G + CA(EP*/P, Y – T)
Consumption
expenditure
as a function
of disposable
income
Investment
expenditure and
government
purchases, both
exogenous
Current account as
a function of the real
exchange rate and
disposable income.
• Or more simply:
D = D(EP*/P, Y – T, I, G)
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(equation 1)
16-12
Determinants of Aggregate Demand
(cont.)
• Determinants of aggregate demand include:
 Real exchange rate: an increase in the real exchange rate
increases the CA, and therefore increases aggregate
demand for domestic products.
 Disposable income: an increase in disposable income
increases C, but decreases the CA by raising home spending
on foreign imports.
• Since C is usually greater than expenditure on foreign products
(IM), an increase in domestic income will raise aggregate
demand for home output.
• As income increases for a given level of taxes, C increases by
less than the increase in income (because of savings) and
aggregate demand increases by less than the increase in C
(because of IM).
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16-13
Short Run Equilibrium for Aggregate
Demand and Output
• Equilibrium is achieved when real domestic
output (Y) equals the aggregate demand for
domestic output (D).
Y = D(EP*/P, Y – T, I, G)
Value of output
and income from
production
Aggregate demand as a function of the
real exchange rate, disposable income,
investment expenditure and government
purchases
Equilibrium condition
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16-14
Fig. 1: The Determination of Output in the SR
Why is Y1 the SR equilibrium
level of output?
If output were lower (Y2) then
spending > output → ↓firms’
inventories → ↑output.
If output were higher (Y3) then
spending < output → ↑firms’
inventories → ↓output.
Short Run Equilibrium and the Exchange
Rate: DD Schedule
• How does the exchange rate affect the SR equilibrium
of aggregate demand and output?
• With fixed price levels at home and abroad, a rise in
the nominal exchange rate makes foreign goods and
services more expensive relative to domestic goods
and services.
• A rise in the nominal exchange rate (a domestic
currency depreciation) increases aggregate demand
for domestic products.
• In equilibrium, production will increase to match the
higher aggregate demand.
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16-16
Fig. 2: Output Effect of a Currency Depreciation
with Fixed Output Prices
A currency depreciation
lowers the relative price of
domestic goods and services.
This improves the CA and
causes the aggregate
demand curve to shift
upward.
Domestic firms respond to the
higher level of spending by
raising their output levels from
Y1 to Y2.
Fig. 3: Deriving the DD Schedule
A depreciation of the domestic
currency shifts the aggregate demand
curve upward causing output to rise.
Point 1 on the DD schedule gives the
output level Y1 at which aggregate
demand equals aggregate supply
when the exchange rate is E1.
A depreciation of the currency to E2
leads to the higher output level Y2
which is shown on point 2 of the DD
schedule.
Short Run Equilibrium and the Exchange
Rate: DD Schedule (cont.)
DD schedule:
• shows combinations of output and the exchange rate
at which the output market is in SR equilibrium (so
that aggregate demand = aggregate output).
• slopes upward because a rise in the exchange rate
causes aggregate demand and aggregate output to
increase.
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16-19
Shifting the DD Curve
•
Changes in the exchange rate cause movements
along the DD curve. Other changes cause it to shift:
1.
Changes in G: more government purchases cause
higher aggregate demand and output in equilibrium.
Output increases for any given exchange rate: the
DD curve shifts out.
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16-20
Fig. 4: Government Spending and the Position
of the DD Schedule
An increase in government
purchases from G1 to G2 shifts
the aggregate demand curve
upward. Firms respond by
increasing their output from Y1 to
Y2.
At a given exchange rate E0, the
higher level of spending and
output leads to an outward shift
of the DD curve.
Shifting the DD Curve (cont.)
2. Changes in T: lower taxes raise Yd and thereby
increase C, increasing aggregate demand and
output in equilibrium for any given exchange rate:
the DD curve shifts out.
3. Changes in I: higher investment expenditure is
represented by shifting the DD curve out.
4. Changes in P relative to P*: lower domestic prices
relative to foreign prices are represented by shifting
the DD curve out.
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16-22
Shifting the DD Curve (cont.)
5.
Changes in C: willingness to consume more and
save less is represented by shifting the DD curve
out.
6.
Changes in demand for domestic goods relative
to foreign goods: willingness to consume more
domestic goods relative to foreign goods is
represented by shifting the DD curve out.
•
Any change that raises aggregate demand for
domestic output shifts DD out; while any change
that lowers aggregate demand for domestic output
shifts DD in.
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16-23
Short Run Equilibrium in Asset Markets
•
We consider two sets of asset markets:
1. Foreign exchange market
 interest parity represents equilibrium:
R = R* + (Ee – E)/E
2. Money market
 Equilibrium occurs when the quantity of real
money supplied matches the quantity of real
money demanded: Ms/P = L(R, Y)
 A rise in income from production causes the real
demand for money to increase.
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16-24
Fig. 5: Output and the Exchange Rate in Asset
Market Equilibrium
Points 1 and 1’ show the
equilibrium interest rate (R1) and
the equilibrium exchange rate (E1)
associated with the output level
Y1.
An increase in output from Y1 to
Y2 raises aggregate real money
demand which raises the interest
rate to R2.
With Ee and R* fixed, the domestic
currency must appreciate to E2.
Short Run Equilibrium in Asset Markets
(cont.)
• When income and output increase,
 aggregate demand for real money increases,
 leading to an increase in domestic interest rates,
 leading to an appreciation of the domestic
currency.
• Similarly, when income and output decrease,
the domestic currency depreciates.
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Short Run Equilibrium in Asset Markets:
AA Curve
AA schedule:
• shows combinations of output and the exchange rate
at which the money market and foreign exchange
market are in equilibrium.
• slopes downward because a rise in output causes the
exchange rate to fall (an appreciation of the domestic
currency).
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16-27
Fig. 6: The AA Schedule
The asset market equilibrium
schedule (AA) slopes downward
because a fall in output causes a
fall in the home interest rate and a
domestic currency depreciation.
Shifting the AA Curve
•
Changes in the exchange rate cause movements
along the AA curve. Other changes cause it to shift:
1.
Changes in Ms: an increase in the money supply
reduces interest rates in the SR, causing the
domestic currency to depreciate (a rise in E) for
every output level (Y): the AA curve shifts up.
•
Figures 7 and 8 illustrate the impact of an increase in the
money supply on the exchange rate and the AA curve.
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16-29
Fig. 7: Exchange Rate Effect of a Money Supply
Increase with Fixed Output
Exchange
rate, E
Decrease in return on domestic currency deposits
Return on
domestic deposits
2'
E2
1'
E1
0
MS 1
P
MS 2
P
Domestic real
money holdings
R2
R1
1
Expected
return on
Domestic
foreign deposits
rates of
return,
L(R, Y1)
interest rate
Domestic real
money supply
2
Increase in domestic
money supply
Fig. 8: Outward Shift of the AA Curve
Exchange
rate, E
E4
c
E3
a
An upward (outward) shift of the
AA curve is shown by the
movement from a to c and from
b to d.
d
E2
b
E1
AA’
AA
Y1
Y2
Output, Y
Shifting the AA Curve (cont.)
2. Changes in P: An increase in the domestic price
level decreases the real money supply, increasing
interest rates, causing the domestic currency to
appreciate (a fall in E): the AA curve shifts down.
3. Changes in real money demand: if domestic
residents prefer to hold a lower amount of real
money balances, interest rates would fall, leading to
a depreciation of the domestic currency (a rise in E):
the AA curve shifts up.
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16-32
Shifting the AA Curve (cont.)
4. Changes in R*: An increase in the foreign interest
rate makes foreign currency deposits more
attractive, leading to a depreciation of the domestic
currency (a rise in E): the AA curve shifts up.
5. Changes in Ee: if market participants expect the
domestic currency to depreciate in the future, foreign
currency deposits become more attractive, causing
the domestic currency to depreciate (a rise in E): the
AA curve shifts up.
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16-33
Putting the Pieces Together: the DD and
AA Curves
•
A SR equilibrium means a nominal exchange
rate and level of output such that:
1. equilibrium in the output market holds: aggregate
demand equals aggregate output.
2. equilibrium in the foreign exchange market holds:
interest parity holds.
3. equilibrium in the money market holds: the quantity
of real money supplied equals the quantity of real
money demanded.
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16-34
Fig. 9: SR Equilibrium: The Intersection of DD
and AA
The SR equilibrium of the
economy occurs at point 1
where the output market
(whose equilibrium points are
summarized by the DD
curve) and asset markets
(whose equilibrium points are
summarized by the AA curve)
simultaneously clear.
This is a SR equilibrium
because output prices are
fixed along the DD and AA
curves.
How the Economy Reaches Its SR
Equilibrium
• Why must E1 be the SR equilibrium exchange rate in
Fig. 10?
• If the exchange rate is E2, then E is expected to fall in
the future so there is an excess demand for domestic
currency in the foreign exchange market.
• The high level of E2 also makes domestic goods
cheap for foreigners, so there is excess demand for
domestic output.
• Excess demand for domestic currency causes an
immediate fall in the exchange rate from E2 to E3.
• At point 3, the asset markets are in equilibrium but
there is still an excess demand for goods.
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How the Economy Reaches Its SR
Equilibrium (cont.)
• As firms raise their output, the economy travels along
AA to point 1 where aggregate demand and supply
are equal at E1.
• Because assets prices can jump immediately while
changes in production take time, the asset markets
remain in equilibrium even while output is increasing.
• E falls from point 3 to point 1 because rising output
causes money demand to increase, pushing the
interest rate up and thereby causing the domestic
currency to appreciate.
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16-37
Fig. 10: How the Economy Reaches Its SR
Equilibrium
If the exchange rate is above its
equilibrium level at E2, then there is
an excess demand for domestic
currency and an excess demand for
domestic output.
There is an immediate fall in the
exchange rate from E2 to E3 to keep
asset markets in equilibrium.
Firms respond to the excess
demand by raising their production.
As output rises, aggregate real
money demand increases which
raises interest rates and causes the
domestic currency to appreciate
from E3 to E1.
Temporary Changes in Monetary and
Fiscal Policy
• Monetary policy: policy in which the central bank
influences the supply of money.
 Monetary policy is assumed to affect asset markets first.
• Fiscal policy: policy in which governments
influence the amount of government purchases and
taxes.
 Fiscal policy is assumed to affect aggregate demand and
output first.
• Temporary policy changes are expected to be
reversed in the near future and thus do not affect the
LR expected exchange rate, Ee.
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16-39
Temporary Changes in Monetary Policy
• An increase in the quantity of money supplied
lowers interest rates in the SR, causing the
domestic currency to depreciate (a rise in E).
 The AA curve shifts up.
 Domestic products relative to foreign products are
cheaper so that aggregate demand and output
increase until a new SR equilibrium is achieved.
 This is shown in Fig. 11.
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16-40
Fig. 11: Effects of a Temporary Increase in the
Money Supply
An increase in the MS at fixed
prices will cause the interest
rate to fall and the domestic
currency to depreciate. This
shifts the AA curve up.
The currency depreciation
increases aggregate demand
and causes output to rise.
Temporary Changes in Fiscal Policy
• An increase in government purchases or a
decrease in taxes increases aggregate
demand and output in the SR.
 The DD curve shifts out.
 Higher output increases real money demand,
 thereby increasing interest rates,
 causing the domestic currency to appreciate
(a fall in E).
 This is shown in Fig. 12.
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16-42
Fig. 12: Effects of a Temporary Fiscal Expansion
A one-time increase in
government spending raises
aggregate demand and
therefore output (Y1 to Y2).
This raises the demand for
real money balances which
pushes interest rates up.
Higher interest rates lead to
an appreciation of the
domestic currency (E1 to E2).
Policies to Maintain Full Employment
• Resources used in the production process can be
over-employed or underemployed.
• When resources are used effectively and sustainably,
economists say that production is at its potential or
full-employment level.
 When resources are not used effectively, resources are
underemployed: high unemployment, few hours worked, idle
equipment, lower than normal production of goods and
services.
 When resources are not used sustainably, labor is overemployed: low unemployment, many overtime hours, overutilized equipment, higher than normal production of goods
and services.
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16-44
Fig. 13: Maintaining Full Employment After a
Temporary Fall in World Demand
A temporary fall in world demand shifts
DD inward reducing output below full
employment and causing the currency
to depreciate from E1 to E2.
Temporary fiscal expansion can restore
full employment by shifting DD back to
its original position.
Temporary monetary expansion can
restore full employment by shifting AA
up.
The fiscal policy restores the currency
to its previous value (E1) while the
monetary policy causes a further
depreciation from E2 to E3.
Fig. 14: Policies to Maintain Full Employment After
an Increase in Money Demand
A temporary increase in the demand
for money pushes up the interest rate
and appreciates the currency, thereby
making domestic goods more
expensive and causing output to
contract.
AA shifts down which lowers output
below its full-employment level.
A temporary money supply increase
would shift AA back to its original
position and restore full employment.
Temporary fiscal expansion shifts DD
out and restores full employment.
However, it also causes a further
appreciation of the currency from E2
to E3.
Policies to Maintain Full Employment
(cont.)
•
Policies to maintain full employment may seem easy
in theory, but are hard in practice.
1. We have assumed that prices and expectations do
not change, but people may anticipate the effects of
policy changes and modify their behavior.

Workers may require higher wages if they expect overtime
and easy employment, and producers may raise prices if
they expect high wages and strong demand due to
expansionary monetary and fiscal policies.

Fiscal and monetary policies may therefore create price
changes and inflation thereby preventing gains in output
and employment: inflationary bias
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16-47
Policies to Maintain Full Employment
(cont.)
2. Economic data are difficult to measure and to
interpret.

It’s difficult for policy makers to know if a disturbance to the
economy originates in the output or asset markets. This is
important in choosing between monetary and fiscal policies.
3. Changes in fiscal policy takes time to be
implemented and to affect the economy.

To avoid procedural delays, governments may respond to
disturbances by using monetary policy even when fiscal
policy is more appropriate.
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16-48
Permanent Changes in Monetary and
Fiscal Policy
4. Policies are sometimes influenced by political or
bureaucratic interests.
•
•
Tax cuts or spending increases may be used to help win
elections without regard to the business cycle.
“Permanent” policy changes are those that are
assumed to modify people’s expectations about
exchange rates in the LR.
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16-49
Permanent Changes in Monetary Policy
• A permanent increase in the quantity of
money supplied:
 lowers interest rates in the SR and makes people
expect future depreciation of the domestic
currency, increasing the expected rate of return on
foreign currency deposits.
 The domestic currency depreciates more than
(E rises more than) the case when expectations
are held constant.
 The AA curve shifts up more than the case when
expectations are held constant.
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16-50
Fig. 15: SR Effects of a Permanent Increase in
the Money Supply
A permanent increase in MS causes the
expected future exchange rate (Ee) to
rise proportionally.
So the upward shift of AA is greater than
that caused by an equal but temporary
increase in MS which does not alter Ee.
Point 3 shows the equilibrium that might
result from a temporary increase in MS.
Effects of Permanent Changes in
Monetary Policy in the LR
• With employment and hours above their normal
levels, there is a tendency for wages to rise over time.
• With strong demand for goods and services and with
increasing wages, producers have an incentive to
raise prices over time.
• Both higher wages and higher output prices are
reflected in a higher price level.
• Fig. 16 illustrates the effects of rising prices.
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16-52
LR Adjustment to a Permanent Increase in
the Money Supply
• The SR equilibrium is at point 2 in Fig. 16 where
output is above full employment.
• Productive factors are working overtime and the price
level is rising to keep up with rising production costs.
• Domestic goods are becoming more expensive than
foreign goods which lowers aggregate demand and
shifts DD in.
• The rising price level also lowers the real money
supply which shifts the AA curve in.
• Both curves stop shifting inward only when they
intersect at full employment (point 3).
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16-53
LR Adjustment to a Permanent Increase in
the Money Supply (cont.)
• AA does not shift all the way back to its original
position because Ee is permanently higher after the
increase in MS.
• Along the adjustment path between the SR (point 2)
and LR equilibrium (point 3), the domestic currency
appreciates from E2 to E3 following its initial sharp
depreciation from E1 to E2. This is an example of
exchange rate overshooting.
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16-54
Fig. 16: LR Adjustment to a Permanent Increase
in the Money Supply
After a permanent money supply
increase, a steadily increasing price
level shifts the DD and AA
schedules inward until the new LR
equilibrium is reached at point 3.
A permanent increase in the money
supply eventually causes all money
prices to rise in proportion (including
E, Ee, and P). However, it has no
lasting effects on output, relative
prices, or interest rates.
Effects of Permanent Changes in Fiscal
Policy
• A permanent increase in government purchases or
reduction in taxes
 increases aggregate demand
 makes people expect the domestic currency will appreciate in
the SR due to increased aggregate demand, thereby
reducing the expected rate of return on foreign currency
deposits and making the domestic currency appreciate.
• The increase in G raises aggregate demand for
domestic products, but the subsequent currency
appreciation lowers aggregate demand for domestic
products (by making exports more expensive).
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16-56
Effects of Permanent Changes in Fiscal
Policy (cont.)
• If the rise in G is permanent, then the fall in net
exports exactly offsets the increase in G, so that
output remains at its full-employment level.
• We say that an increase in government purchases
completely crowds out net exports, due to the effect
of the appreciated domestic currency.
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16-57
Fig. 17: Effects of a Permanent Fiscal Expansion
A permanent increase in G causes a LR
appreciation of the currency. The
resulting fall in Ee shifts AA down.
Point 2 is the SR equilibrium where the
currency has appreciated from E1 to E2
and output remains unchanged at Yf.
By contrast, a comparable temporary
increase in G would leave the economy
at point 3 (with higher output).
A temporary change in G does not alter
Ee and therefore does not shift AA.
Note that prices (P) do not change
because MS and L(R,Y) do not change.
Macroeconomic Policies and the Current
Account
• To determine the effect of monetary and fiscal policies
on the current account,
 derive the XX curve to represent the combinations of output
and exchange rates at which the current account is at its
desired level.
• As income from production increases, imports
increase and the current account decreases when
other factors remain constant.
• To keep the current account at its desired level, the
domestic currency must depreciate as income from
production increases: the XX curve should slope
upward.
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16-59
Fig. 18: How Macroeconomic Policies Affect the CA
Along XX, the CA is constant and
equal to a desired level, X.
Temporary monetary expansion
shifts AA out and moves the
economy to point 2 and thus raises
the CA balance.
Temporary fiscal expansion shifts
DD out and moves the economy to
point 3.
Permanent fiscal expansion shifts
DD out and AA in and moves the
economy to point 4.
The CA balance falls with any fiscal
expansion.
Macroeconomic Policies and the Current
Account (cont.)
• The XX curve slopes upward but is flatter than
the DD curve.
 DD represents equilibrium values of aggregate
demand and domestic output.
 As domestic income and production increase,
domestic saving increases, which means that
aggregate demand (willingness to spend) by
domestic residents does not rise as rapidly as
income and production.
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16-61
Macroeconomic Policies and the Current
Account (cont.)
 As domestic income and production increase, the
domestic currency must depreciate to entice
foreigners to increase their demand for domestic
products in order to keep the current account (only
one component of aggregate demand) at its
desired level—on the XX curve.
 As domestic income and production increase, the
domestic currency must depreciate more rapidly to
entice foreigners to increase their demand for
domestic products in order to keep aggregate
demand (by domestic residents and foreigners)
equal to production—on the DD curve.
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16-62
Macroeconomic Policies and the Current
Account (cont.)
• Policies affect the current account through
their influence on the value of the domestic
currency.
 An increase in the quantity of money supplied
depreciates the domestic currency and often
increases the current account in the SR.
 An increase in government purchases or decrease
in taxes appreciates the domestic currency and
often decreases the current account in the SR.
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Value Effect, Volume Effect, and the
J-curve
• If the volume of imports and exports is fixed in the SR,
a depreciation of the domestic currency
 will not affect the volume of imports or exports,
 but will increase the value/price of imports in domestic
currency and decrease the current account: CA ≈ EX – IM.
 The value of exports in domestic currency does not change.
• The current account could immediately decrease after
a currency depreciation, then increase gradually as
the volume effect begins to dominate the value effect.
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16-64
Fig. 19: The J-Curve
volume effect
dominates
value effect
Immediate
effect of real
depreciation
on the CA
J-curve: value
effect dominates
volume effect
Six months to
one year
Value Effect, Volume Effect, and the Jcurve (cont.)
• Pass through from the exchange rate to import
prices measures the percentage by which import
prices change when the value of the domestic
currency changes by 1%.
• In the DD-AA model, the pass through rate is 100%:
import prices in domestic currency exactly match a
depreciation of the domestic currency.
• In reality, pass through may be less than 100% due to
price discrimination in different countries.
 E.g., foreign firms selling in the U.S. may not want to raise
their U.S. prices by 10% when the dollar depreciates by 10%
because they do not want to lose market share.
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16-66
Value Effect, Volume Effect, and the Jcurve (cont.)
• If prices of foreign products in domestic currency do
not change much because of a pass through rate less
than 100%, then the
 value of imports will not rise much after a domestic currency
depreciation, and the current account will not fall much,
making the J-curve effect smaller.
 volume of imports and exports will not adjust much over time
since domestic currency prices do not change much.
• Pass through of less than 100% dampens the effect
of depreciation or appreciation on the current account.
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16-67