Chapter 20 Model Apps

Exchange Rates and International Finance

Explore the models of Chapter 20 without any code. Every chart below is live: move its slider to change one part of the model and watch the curves respond, and hover over a line to read its values.

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See also: Chapter 20 Data Apps, the chapter’s data without code.

The open economy in the short-run model

Fig. 4: Increasing interest rates and the IS curve

Move the slider to change how strongly net exports react to the interest rate; watch the IS curve turn flatter and point B move left.

\[ \frac{NX_t}{\bar{Y}_t} = \bar{a}_{nx} - \bar{b}_{nx}\,(R_t - \bar{R}^w) \]

\[ \tilde{Y}_t = \bar{a} - (\bar{b}_i + \bar{b}_{nx})\,(R_t - \bar{r}) \]

where \(\tilde{Y}_t\) is short-run output, \(R_t\) the real interest rate, raised here from \(\bar{r} = 5\) to 6 percent, and \(\bar{b}_i = 1\) the sensitivity of investment.

Takeaway. A higher real interest rate lowers investment and, through a stronger dollar, net exports, so each point of interest lowers output by \(\bar{b}_i + \bar{b}_{nx}\) percent. A larger net-export sensitivity turns the IS curve flatter around point A and moves B further left, so monetary policy gets more powerful. At zero only investment reacts, as in a closed economy.

Source. Adapted from Fig. 20.4 in Jones (2024), Macroeconomics, 6th ed.

Fig. 5: An increase in foreign interest rates

Move the slider to step through the periods; watch the economy jump from A to B, climb toward C, drop to D and return.

\[ \bar{a} = \bar{b}_{nx}\,(\bar{R}^w - \bar{r}) \]

\[ \tilde{Y}_t = \bar{a} - \bar{b}\bar{m}\,(\pi_t - \bar{\pi}) \]

\[ \pi_t = \pi_{t-1} + \bar{\nu}\tilde{Y}_t \]

where the foreign real rate \(\bar{R}^w\) is 2 points above \(\bar{r}\) in periods 1 to 9, \(\bar{m}\) is the policy response and \(\bar{\nu}\) the slope of the Phillips curve.

Takeaway. A higher foreign rate weakens the dollar and raises net exports, a demand shock that shifts AD out in periods 1 to 9: output jumps above potential, then inflation climbs toward 4 percent as output returns to potential. When the foreign rate falls back in period 10, AD shifts back and the economy drops into a recession, then slides down AD to its starting point. The U.S. did nothing, yet its economy boomed and slumped.

Source. Adapted from Fig. 20.5 in Jones (2024), Macroeconomics, 6th ed.

Exchange-rate regimes and the policy trilemma

Fig. 7: The policy trilemma in open economies

Move the slider to switch regimes after a 1-point rise in the foreign interest rate; watch which corner of the triangle is lost.

\[ 1 + i_t = (1+i^w)\,\frac{E_t}{E^e_{t+1}} \]

\[ \%\Delta E = \eta\,(\Delta i - \Delta i^w) \]

\[ i_t = i^w \]

where \(E\) is the exchange rate, \(i\) and \(i^w\) the interest rates at home and abroad, and \(\eta = 5\) percent per point of interest gap; the last line holds under a credible peg.

Takeaway. Uncovered interest parity ties the exchange rate, the interest rate and free capital flows together, so a country can choose any two and the third follows. After the foreign rate rises by 1 point, a floating rate keeps the interest rate and lets the currency depreciate, a currency board holds the exchange rate by raising the interest rate although the economy did not need it, and capital controls keep both only by blocking capital flows.

Source. Adapted from Fig. 20.7 in Jones (2024), Macroeconomics, 6th ed.