4- The Open Economy Flashcards
What is the nominal exchange rate (E)?
The rate at which one currency can be exchanged for another
What is the formula for the real exchange rate (R)?
R = (EP^w)/P
What does the real exchange rate (R) measure?
Relative prices in terms of domestic currency
What happens to E if there is a depreciation in the nominal exchange rate?
E increases
What happens to R if there is a depreciation in the real exchange rate?
R increases
What are 3 main reasons for the real exchange rate depreciating?
- Nominal exchange rate depreciation (increase in E)
- Foreign price level increase (increase in P^w)
- Domestic price level decrease (decrease in P)
What does the expression EP^w tell us?
The price of foreign goods in terms of domestic currency
What happens to imports when R depreciates (increases)?
There is a reduction in imports
What is the expression for the relative price of domestic goods in terms of foreign currency?
P/EP^w
This is the inverse of R
What happens to exports when R depreciates (increases)?
There is an increase in exports
How does the real exchange rate affect the IS curve when considering the open economy?
Depreciation in R (increase) would shift the curve up
What is the capital account (CP)?
The sum of cross-border financial transactions that do not involve the public sector
What does the Uncovered Interest rate Parity (UIP) condition state?
The UIP states that the domestic interest rate equals the foreign interest rate plus the expected rate of depreciation of the domestic currency
What is the balance of payments (BoP)?
The sum of the current account and the capital account
What is m1?
The sensitivity of imports to income increases
