3. Open Economy Macroeconomics

Question 1

What type of economy is New Zealand?

Answer 1

Small open economy

• buying and selling goods and services in world product markets
• buying and selling financial assets

Question 2

Trade Balance

Answer 2

Value of a nation’s exports minus the value of its imports (Net Exports)

Question 3

Trade Surplus

Answer 3

Exports > Imports

Question 4

Trade Deficit

Answer 4

Exports < Imports

Question 5

Balanced Trade

Answer 5

Exports = Imports

Question 6

Current Account Balance (CAB)

Answer 6

The sum of net exports (NX) and net foreign income (NFI)

CAB = NX + NFI

Question 7

Net Capital Outflow (NCO)

Answer 7

Purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners

Question 8

The purchase of a foreign asset by a domestic resident has what form of impact on NCO?

Answer 8

Positive

Question 9

The purchase of a domestic asset by foreigner has what impact on NCO?

Answer 9

Negative

Question 10

Capital Account Balance (KAB)

Answer 10

Difference between total receipts from the sale of domestic assets to foreigners and total payments abroad

Question 11

NCO is equal to…

Answer 11

negative of the capital account balance (KAB)

Question 12

Purchases of an investment is recorded in…

Answer 12

The Capital Account (KAB)

Question 13

Balance of Payments Condition

Answer 13

The CAB must equal NCO

Question 14

2 uses for domestic savings in an open economy

Answer 14

1. Domestic Investment

2. Purchase of Foreign Assets

Question 15

2 sources of domestic investment in an open economy

Answer 15

1. Domestic Savers
2. Foreign Funds
   - If S < I, part of investment financed from abroad, decrease in NCO, foreigners gain claim on domestic assets
   - If S > I, part of savings funds are investment abroad, increase in NCO, domestic residents gain a claim of foreign assets

Question 16

Nominal Exchange Rate

Answer 16

Rate at which a person can trade the currency of one country for the currency of another

Question 17

Ways to express exchange rate

Answer 17

Units of foreign currency per unit of domestic currency (USD$0.82 per NZ dollar)

Question 18

Appreciation

Answer 18

Increase in the value of a currency as measure by the amount of foreign currency it can buy (strengthening of the dollar)

Question 19

Depreciation

Answer 19

Decrease in the value of a currency as a measure by the amount of foreign currency it can buy (weakening of the dollar)

Question 20

Trade-weighted Index

Answer 20

An exchange rate index for the NZ dollar that comprises the currencies of Australia, the Euro zone, Japan, US and UK

Question 21

Real Exchange Rate

Answer 21

Rate at which a person can trade the goods and services of one country for the goods and services of another country

Question 22

The Real Exchange Rate is a key determinant of…

Answer 22

Net exports of goods and services

Question 23

Depreciation in NZ real exchange rate

Answer 23

NZ goods become cheaper relative to foreign goods - exports rise, NX rises

Question 24

Appreciation in NZ real exchange rate

Answer 24

NZ goods become more expensive relative to foreign goods - imports rise, NX falls

Question 25

Purchasing Power Parity (PPP)

Answer 25

Theory of exchange rates whereby a unit of any given currency should be able to buy the same amount of goods and services in all countries

Question 26

What does the Purchasing Power Parity imply?

Answer 26

Nominal exchange rates will be determined so that, NZ$3 will buy a 500ml bottle of coke in all countries

Question 27

Purchasing Power Parity is based on

Answer 27

Law of One Price

• a good must sell for the same price in all locations
• assumes away significant trade/arbitrage costs