THE INSULATION EFFECT UNDER FLEXIBLE EXCHANGE RATES
1979 Volume 30 Issue 2 Pages 143-149
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1979 Volume 30 Issue 2 Pages 143-149
In this paper we have developed a model where the terms of trade effect concentrated by Laursen-Metzler and capital flows by Mundell are synthesized, and have analyzed the international transmission process of policy effects under flexible exchange rates, and have derived the following results.
When the interest rate sensitivity of capital flows (K') is zero,
(1) if the domestic interest rate sensitivity of total private expenditures (Ei) is zero, the perfect insulation arises in the sense that a domestic increase in the money supply has no effects on the foreign employment level and real income deflated by the general price index which is a weighted average of the price of goods and services produced in the two countries.
(2) if the foreign interest rate sensitivity of the demand for money (Li*) is extremely large, a domestic monetary expansion leads to a decrease in the foreign employment level, but to an increase in the foreign real income through the sufficient improvement of the terms of trade.
When K' is not zero,
(3) if Ei and the foreign interest rate sensitivity of total private expenditures (Ei*) are sufficiently small, and Li* is extremely large, a domestic monetary expansion gives rise not only to a decrease in the foreign employment level but to a decrease in the real income.
When K' is not zero,
(4) if Li* is extremely large, a domestic exogeneous increase in the demand for domestic goods leads to a decrease in the foreign employment level, but to an increase in the real income.
(5) if Ei* is zero, a domestic exogeneous increase in the demand for domestic goods has no effects on the foreign real income, but results in a decrease in the foreign employment level.
When K' is not zero,
(6) if Ei* is sufficiently small, and both Li and Li* are extremely large, a domestic exogeneous increase in the demand for domestic goods gives rise to a decrease in the foreign employment level, but contrastively to an increase in the foreign real income through the sufficient improvement of the terms of trade.
