Effect of Monetary Policy in the United States and Other OECD Countries Table 18.3 shows the effect of a 4 percent increase in the money supply (expansionary monetary policy) in the United States or in other OECD countries on the gross national product (GNP), consumer price index (CPI), interest rate, currency value, and current account of the United States and other OECD countries. The OECD—the Organization for Economic Cooperation and Development—included all 24 of the world’s industrial countries at the time of the exercise. The simulation results were obtained by using the Multi-Country Model of the Federal Reserve Board. Although the effects of an increase in the money supply are felt over several years, the results reported in Table 18.3 show the effect in the second year after the money supply increased. Part A of the table shows that a 4 percent increase in the U.S. money supply results (through the multiplier process) in a 1.5 percent increase in U.S. GNP the year after the United States increased its money supply. A longer period of time would show a larger total effect. It also leads to a 0.4 percent increase in the U.S. prices, a 2.2 percentage points decline (say, from 6.2 percent to 4.0 percent) in the U.S. short-term interest rate, a 6.0 percent decrease in the international value of the dollar (depreciation), and a $3.1 billion deterioration in the U.S. current account balance (because the tendency of U.S. imports to rise due to higher GNP overwhelms the tendency of the dollar depreciation to improve the U.S. current account). The top right part of the table shows that the increase in the U.S. money supply leads to a reduction in the growth of GNP in the rest of the OECD countries of 0.7 percent, a 0.6 percent fall in prices, a 0.5 percentage point reduction in the short-run interest rate, and a deterioration in the current account balance of $3.5 billion. The effect on the foreign exchange rates of the rest of OECD was not estimated. The reduction in the GNP of the rest of the world may seem strange in view of the increase in U.S. imports. But the increase in U.S. imports may be coming from the rest of the world (developing and OPEC countries) rather than from other OECD countries. Furthermore, the repercussions of an expansionary monetary policy in the United States do not operate only through trade and are too intricate to evaluate by logical reasoning alone. That’s why we need a model. Part B of the table shows that a 4 percent increase in the money supply in the rest of OECD would lead to a 1.5 percent increase in the average GNP, a 0.6 percent increase in prices, a 2.1 percentage point reduction in the short-term interest rate, a 5.4 percent currency depreciation, and a $3.5 billion improvement in the current account balance of the rest of OECD. These changes have repercussions in the United States, where prices fall by 0.2 percent, short-term interest rates decrease by 0.2 percentage points, and the U.S. current account improves by $0.1 billion. The net effect on U.S. GNP is nil, and the effect on the exchange rate of the dollar was not estimated.

Effect of Monetary Policy in the United States and Other OECD Countries Table 18.3 shows the effect of a 4 percent increase in the money supply (expansionary monetary policy) in the United States or in other OECD countries on the gross national product (GNP), consumer price index (CPI), interest rate, currency value, and current account of the United States and other OECD countries. The OECD—the Organization for Economic Cooperation and Development—included all 24 of the world’s industrial countries at the time of the exercise. The simulation results were obtained by using the Multi-Country Model of the Federal Reserve Board. Although the effects of an increase in the money supply are felt over several years, the results reported in Table 18.3 show the effect in the second year after the money supply increased. Part A of the table shows that a 4 percent increase in the U.S. money supply results (through the multiplier process) in a 1.5 percent increase in U.S. GNP the year after the United States increased its money supply. A longer period of time would show a larger total effect. It also leads to a 0.4 percent increase in the U.S. prices, a 2.2 percentage points decline (say, from 6.2 percent to 4.0 percent) in the U.S. short-term interest rate, a 6.0 percent decrease in the international value of the dollar (depreciation), and a $3.1 billion deterioration in the U.S. current account balance (because the tendency of U.S. imports to rise due to higher GNP overwhelms the tendency of the dollar depreciation to improve the U.S. current account). The top right part of the table shows that the increase in the U.S. money supply leads to a reduction in the growth of GNP in the rest of the OECD countries of 0.7 percent, a 0.6 percent fall in prices, a 0.5 percentage point reduction in the short-run interest rate, and a deterioration in the current account balance of $3.5 billion. The effect on the foreign exchange rates of the rest of OECD was not estimated. The reduction in the GNP of the rest of the world may seem strange in view of the increase in U.S. imports. But the increase in U.S. imports may be coming from the rest of the world (developing and OPEC countries) rather than from other OECD countries. Furthermore, the repercussions of an expansionary monetary policy in the United States do not operate only through trade and are too intricate to evaluate by logical reasoning alone. That’s why we need a model. Part B of the table shows that a 4 percent increase in the money supply in the rest of OECD would lead to a 1.5 percent increase in the average GNP, a 0.6 percent increase in prices, a 2.1 percentage point reduction in the short-term interest rate, a 5.4 percent currency depreciation, and a $3.5 billion improvement in the current account balance of the rest of OECD. These changes have repercussions in the United States, where prices fall by 0.2 percent, short-term interest rates decrease by 0.2 percentage points, and the U.S. current account improves by $0.1 billion. The net effect on U.S. GNP is nil, and the effect on the exchange rate of the dollar was not estimated.

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Chapter1: Making Economics Decisions

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CASE STUDY 18-4

Effect of Monetary Policy in the United States and Other OECD Countries

Table 18.3 shows the effect of a 4 percent increase in the money supply (expansionary monetary policy) in the United States or in other OECD countries on the gross national product (GNP), consumer price index (CPI), interest rate, currency value, and current account of the United States and other OECD countries. The OECD—the Organization for Economic Cooperation and Development—included all 24 of the world’s industrial countries at the time of the exercise. The simulation results were obtained by using the Multi-Country Model of the Federal Reserve Board. Although the effects of an increase in the money supply are felt over several years, the results reported in Table 18.3 show the effect in the second year after the money supply increased. Part A of the table shows that a 4 percent increase in the U.S. money supply results (through the multiplier process) in a 1.5 percent increase in U.S. GNP the year after the United States increased its money supply. A longer period of time would show a larger total effect. It also leads to a 0.4 percent increase in the U.S. prices, a 2.2 percentage points decline (say, from 6.2 percent to 4.0 percent) in the U.S. short-term interest rate, a 6.0 percent decrease in the international value of the dollar (depreciation), and a $3.1 billion deterioration in the U.S. current account balance (because the tendency of U.S. imports to rise due to higher GNP overwhelms the tendency of the dollar depreciation to improve the U.S. current account). The top right part of the table shows that the increase in the U.S. money supply leads to a reduction in the growth of GNP in the rest of the OECD countries of 0.7 percent, a 0.6 percent fall in prices, a 0.5 percentage point reduction in the short-run interest rate, and a deterioration in the current account balance of $3.5 billion. The effect on the foreign exchange rates of the rest of OECD was not estimated. The reduction in the GNP of the rest of the world may seem strange in view of the increase in U.S. imports. But the increase in U.S. imports may be coming from the rest of the world (developing and OPEC countries) rather than from other OECD countries. Furthermore, the repercussions of an expansionary monetary policy in the United States do not operate only through trade and are too intricate to evaluate by logical reasoning alone. That’s why we need a model. Part B of the table shows that a 4 percent increase in the money supply in the rest of OECD would lead to a 1.5 percent increase in the average GNP, a 0.6 percent increase in prices, a 2.1 percentage point reduction in the short-term interest rate, a 5.4 percent currency depreciation, and a $3.5 billion improvement in the current account balance of the rest of OECD. These changes have repercussions in the United States, where prices fall by 0.2 percent, short-term interest rates decrease by 0.2 percentage points, and the U.S. current account improves by $0.1 billion. The net effect on U.S. GNP is nil, and the effect on the exchange rate of the dollar was not estimated.

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