9.Open Economy Macroeconomics

Question 1

Current account items

Answer 1

net goods trade
services trade
international investment income
current transfers

Question 2

current account debt indicates

Answer 2

‘borrowed lifestyle’ domestic savings being supplemented by foreign savings

Question 3

Capital account

Answer 3

measures the imbalance between amount of foreign assets bought by domestic, and domestic assets bought by foreigners

Question 4

examples of capital inflow and outflow

Answer 4

when foreigners buy domestic bonds -> capital inflow

when domestic people buy foreign bonds -> capital outflow

Question 5

how to limit foreign investment

Answer 5

bring national expenditure closer to national earnings (lower standard of living)

increase proportion of domestic investment from domestic savings

Question 6

net capital outflow influences

Answer 6

real interest rate on foreign assets
real interest rate on domestic assets
perceived economic and political risks of holding assets abroad
the government policies that affect foreign ownership of domestic assets

Question 7

if there is a current account deficit, then NX and NFI must be

Answer 7

negative (NX is the goods and services net, first two items in the current account, NFI are the second two items international investments and current transfers )

Question 8

Balance of payments two items

Answer 8

current account, capital account

Question 9

hard currencies

Answer 9

stable currencies with high demand

Question 10

floating vs fixed

Answer 10

free to settle at equilibrium; fixed is fixed by government

Question 11

NZ interest rates rise relative to foreign rates

Answer 11

demand for NZD rises (foreign investors want to invest in NZ), supply of NZD falls (NZ investors less inclined to invest overseas)

Question 12

factors influencing equilibrium exchange rate

Answer 12

TRADE
relative interest rates
relative rate of inflation
level of prosperity of trading partners

Question 13

Trade weighted index

Answer 13

weighted average of currencies of major trading partners

loosely based on importance in overseas trade transactions

provides more balanced measure of value of NZD over time

Question 14

supply of NZD in foreign exchange market

Answer 14

comes from the demand for foreign currency, slopes up

Question 15

demand of NZD in foreign exchange market

Answer 15

comes from the supply of foreign currency, slopes down

Question 16

real exchange rate

Answer 16

the real exchange rate is the rate at which a country trades its goods and services with another country

Question 17

purchasing power parity, and why does it hold

Answer 17

states that cost of goods should be equal (or almost) in all countries. This is due to arbitrage, if a good was cheaper in country B, then merchants would buy up in B and sell to A until the price was about equal

Question 18

Real exchange rate

Answer 18

nominal exchange rate x domestic price/ foreign price

Question 19

a fall in nominal exchange rate

Answer 19

leads to a fall in real exchange rate (as nominal x domestic price/foreign price) which makes the country more competitive

Question 20

a decrease/depreciation in the real exchange rate

Answer 20

means that NZ goods are cheaper relative to foreign goods, encouraging foreigners to buy NZ goods. This also means an appreciation of foreign real exchange rate, discouraging NZers to buy foreign goods.

Question 21

What affects real exchange rate?

Answer 21

inflation (it rises when NZ inflation exceeds trading partners’ @ constant nominal rate - see equation)

nominal exchange rate increases

Question 22

limits of purchasing power parity

Answer 22

goods not easily shipped or traded;
tradable goods are not perfect substitutes (ie different beers)
also services do not fall under this parity

Question 23

effect of government budget deficit in a small open economy

Answer 23

no crowding out as reduction in savings is almost always offset by funds from abroad but investment does not change

Question 24

trade policies affect micro or macro more?

Answer 24

micro Only helped the industry that the policy targets. They do not reduce exchange rate - as buying less reduces the supply of money, increasing the exchange rate

Question 25

effect of subsidy on exports or tax on imports

Answer 25

imports decrease, exports increase, this results in an increase in net exports -> increases demand for a country’s currency

Question 26

promoting trade effects

Answer 26

no effect of the interest rate (as loanable funds market not affected)

no change in net exports or CAB. As the increase in exports will cause an appreciation of the dollar resulting in encouraging imports and discouraging exports