Open-Economy Macroeconomics Basic Concepts. Outline: Closed versus open economy Key macroeconomic...
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Transcript of Open-Economy Macroeconomics Basic Concepts. Outline: Closed versus open economy Key macroeconomic...
Outline: Closed versus open economy Key macroeconomic variables in an
open economy Understanding and interpretation of
data
Closed versus open Closed economy is an economy that
does not interact with other economies in the world
Open economy is an economy that interacts freely with other economies in the world
International flows of goods Exports: goods and services that are
produced domestically and sold abroad
Imports: goods and services that are produced abroad and sold domestically
Net exports: the value of a nation’s exports minus the value of its imports
International flows of goods Trade balance: also called as net
exports Trade surplus: an excess of exports
over imports, i.e. net exports are positive
Trade deficit: an excess of imports over exports, i.e. net exports are negative
Balanced trade: Exports and imports are equal, i.e. net exports are zero
Factors affecting international trade in goods and services
Tastes of consumers for domestic and foreign goods
Prices of goods at home and abroad Exchange rate of domestic currency Income of consumers at home and
abroad Cost of transportation Policies of government towards trade
Increasing openness of Canadian economy: Reasons
Improvements in transportation Advances in telecommunications Technological progress Free Trade Agreement in 1989 NAFTA in 1993
International flow of capital Net foreign investment: the purchase of
foreign assets by domestic residents minus the purchase of domestic assets by foreigners
Foreign Direct Investment (FDI): is investment that gives foreign investor management control of the domestic firm in which the investment is made
Foreign Portfolio Investment: are foreign holdings of government and private sector debt (bonds and shares) and involves no legal control.
Variables influencing net foreign investment
Real interest rates paid on foreign assets
Real interest rates paid on domestic assets
Perceived risk of holding assets abroad
Government policies that affect foreign ownership of domestic assets
Net Exports (NX)= Net Foreign Investment (NFI)
Exports > Imports + NX
Canadian resident
Purchases foreign stock
+ NFI
Foreign resident
Purchases Canadian stock - NFI
+ NX
+ NFI
USA
Canada USA
Good is exported
Pays in USD
Canada
Invest in US bonds
Imports US goods No change in NX
and NFI
NX=NFI
+ NX=+ NFI
Conclusion:
Value of asset= value of goods and services sold
NFI=NX International flow of goods=
international flow of capital
Saving= domestic investment+ net foreign investment
Saving, Investment, and international flows
Savings in Canadian economy
Investment in the
Canadian economy
Canadian NFI
Exports and Imports: Canada
0
100000
200000
300000
400000
500000
600000
Year Q1
Exp
ort
s, Im
po
rts
Exports
Imports
Relation between saving, investment, and NFI: Canada’s experience
• Refer transparencies for slides or pp. 382 of the text book.
Prices for international transactions: Exchange Rates
Nominal exchange rate: Rate at which a person can trade the currency of one country for the currency of another
Appreciation: An increase in the value of a currency as measured by the amount of foreign currency it can buy
Depreciation: A decrease in the value of a currency as measured by the amount of foreign currency it can buy
Exchange rate determination: PPP
PPP is a theory of exchange rate whereby a unit of any given currency should be able to buy the same quantity of goods in all countries, i.e., a unit of all currencies must have the same real value in every country.
Implications: Nominal exchange rate between the currencies of the two
countries depends on the price levels in those countries. Nominal exchange rates change when the price levels change. Increase in the supply of money lowers value of money and
depreciates the nominal exchange rate of the currency as well.
PPP Theory: Limitations Many goods are not easily traded between
countries limiting the arbitrage that can be gained from difference in prices.
Tradable goods are not perfect substitutes
Conclusion: Changes in the real exchange rate are often small and temporary. Large changes in nominal exchange rates reflect changes in price levels at home and abroad.
Interest rate determination Assumptions:
Small open economy Perfect capital mobility
Interest parity is a theory of interest rate determination whereby the real interest rate on comparable financial assets should be the same in all economies with full access to world financial markets.
Limitations: Possibility of default Financial assets are imperfect substitutes Differences in default risk and in tax treatments
• Domestic price of steel • Quantity of steel produced• Quantity of steel consumed• Quantity of steel exported• Consumer surplus• Producer surplus• Government revenue• Total surplus
Consider a small country that exports steel. Suppose that a pro-trade government decides to subsidize steel by paying a certain amount for each ton of steel sold abroad. What are the effects of the export subsidy on :
• A Canadian spends his summer in Europe• Students in Paris come to watch whales in Victoria, BC • A Canadian cellular phone co establishes an office in
the USA• TD mutual fund sells its Volkswagen stock to a French
investor • Your uncle buys a new Volvo• A Canadian citizen shops at a store in NY to avoid
Canadian sales tax • Harrod’s of London sells stock to the Ontario Teachers’
Pension Plan • Macey’s in NY is selling Roots T-shirts
How would the following transactions affect Canada's imports, exports, net exports, and net foreign investment?