ECON 3560/5040 Week International Flows of Capital and Goods. = domestic spending + foreign spending

Transcription

1 ECON 3560/5040 Week 10 THE OPEN ECONOMY 1. International Flows o Capital an Goos (1) The Role o Net Exports Y = C + I + G + EX = omestic spening + oreign spening where C : consumption o omestic goos an services I : investment in omestic goos an services G : gov t purchase o omestic goos an services EX : exports o omestic goos an services Y = ( C C ) + ( I I ) + ( G G ) + EX = C + I + G + EX ( C + I + G ) = C + I + G + EX IM = C + I + G + NX where IM : the sum o omestic spening on oreign goo an services NX : net exports

2 NX = Y ( C + I + G) = output omestic spening In an open economy, omestic spening nee not equal the output o goos an services. I output > omestic spening net exports > 0 I output < omestic spening net exports < 0 (2) Net Foreign Investment (Net Capital Outlow) an the Trae Balance Y = ( C + I + G) + NX Y C G = S = I + S I = NX NX An economy s net exports (trae balance) must always equal to the ierence b/t its saving an its investment (net oreign investment or net capital outlow) I I I S I = NX > 0 trae surplus S I = NX < 0 trae eicit S I = NX = 0 balance trae The national income accounts ientity shows the international low o uns to inance capital accumulation an the international low o goos an services are two sies o the same coin.

3 2. Saving an Investment in a Small Open Economy In a close economy, real interest rate ajust to equilibrate saving an investment But in an open economy, the real interest rate oesn t. allow the economy to run a trae surplus (eicit) What oes etermine the real interest rate? Assuming a small open economy with perect capital mobility, the interest rate must equal to the worl interest rate,. Note: worl interest rate is an exogenous given variable (b/c a small economy has a negligible eect on worl saving an worl investment) (1) Moel - Assumptions: Y = Y = F( K, L) C = C( Y T ) I = I(r*) - Trae balance is etermine by the ierence b/t saving an investment at the worl interest rate (ig. 5-2) NX = S I = ( Y C( Y T ) G) I( r*)

4 (2) How Policies Inluence the Trae Balance - Assumption: a position o balance trae (NX = 0) (a) Fiscal policy at home (ig. 5-3) G (or T ) S NX Starting rom balance trae, a change in iscal policy that reuces national saving leas to a trae eicit (b) Fiscal policy abroa (ig. 5-4) I the oreign countries are a large part o the worl economy, G * (or T * ) S* r* NX Starting rom balance trae, an increase in the worl interest rate ue to a iscal policy expansion leas to a trae surplus (c) Shits in investment eman (ig. 5-5) e.g., investment tax creit I NX Starting rom balance trae, an outwar shit in the investment scheule causes a trae eicit

5 3. Exchange Rates (1) Nominal an Real Exchange Rates Nominal exchange rate: the relative price o the currency o two countries e.g., the exchange rate b/t the US ollar an the Japanese Yen is 120 yen per ollar Real exchange rate: the relative price o the goos o two countries (= terms o trae) e.g., American pizza: $1 (=120yen), Japanese pizza: 240yen. Real Exchange Rate = (120 yen/$) ($1/American pizza) 240 yen/japanese pizza = 0.5 Japanese pizza American pizza American pizza costs one-hal o what Japanese pizza costs Real EXRA( ε ) = Nominal EXRA( e ) Ratio o price level( P / P*) I ε is high (low), oreign goos are relatively cheap (expensive), an omestic goos are relatively expensive (cheap)

6 (2) The Determinants o the Real Exchange Rate (a) The real EXRA an the trae balance (ig. 8-7) The lower ε, the less expensive are omestic goos relative to oreign goos. the greater are our net exports NX = NX (ε ) (b) trae balance(nx) = net oreign investment (S I) From (a) an (b), At the equilibrium real exchange rate, The supply o ollars available or net oreign investment balances the eman or ollars by oreigners buying our net exports (ig. 5-8) (3) How Policies Inluence the Real Exchange Rate (a) Fiscal policy at home (ig. 5-9) (b) Fiscal policy abroa (ig. 5-10) (c) Shits in investment eman (ig. 5-11) () The eects o trae policies (ig. 5-12) e.g., The impact o protectionist trae policies raise the eman or net exports raise the exchange rate

7 (4) The Determinants o the Nominal Exchange Rate Real EXRA( ε ) = Nominal EXRA( e ) Ratio o price level( P / P*) Nominal EXRA( e ) = Real EXRA( ε ) Ratio o price level( P * / P) (a) Given ε, i the omestic price level ( P) That is, b/c a ollar is worth less, a ollar will buy ewer yen (b) Given ε, i the oreign price level ( P*) That is, b/c the yen is worth less, a ollar will buy more yen e e - Inlation an Nominal EXRA e = ε ( P * / P) % Δ e = % Δ ε + % Δ P * - % = % Δ ε + ( π * - π ) Δ P I a country has a high (low) rate o inlation relative to the US, a ollar will buy an increasing (ecreasing) amount o the oreign currency overtime (ig. 5-13)