9.Open Economy Macroeconomics Flashcards
Current account items
net goods trade
services trade
international investment income
current transfers
current account debt indicates
‘borrowed lifestyle’ domestic savings being supplemented by foreign savings
Capital account
measures the imbalance between amount of foreign assets bought by domestic, and domestic assets bought by foreigners
examples of capital inflow and outflow
when foreigners buy domestic bonds -> capital inflow
when domestic people buy foreign bonds -> capital outflow
how to limit foreign investment
bring national expenditure closer to national earnings (lower standard of living)
increase proportion of domestic investment from domestic savings
net capital outflow influences
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
if there is a current account deficit, then NX and NFI must be
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 )
Balance of payments two items
current account, capital account
hard currencies
stable currencies with high demand
floating vs fixed
free to settle at equilibrium; fixed is fixed by government
NZ interest rates rise relative to foreign rates
demand for NZD rises (foreign investors want to invest in NZ), supply of NZD falls (NZ investors less inclined to invest overseas)
factors influencing equilibrium exchange rate
TRADE
relative interest rates
relative rate of inflation
level of prosperity of trading partners
Trade weighted index
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
supply of NZD in foreign exchange market
comes from the demand for foreign currency, slopes up
demand of NZD in foreign exchange market
comes from the supply of foreign currency, slopes down
real exchange rate
the real exchange rate is the rate at which a country trades its goods and services with another country
purchasing power parity, and why does it hold
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
Real exchange rate
nominal exchange rate x domestic price/ foreign price
a fall in nominal exchange rate
leads to a fall in real exchange rate (as nominal x domestic price/foreign price) which makes the country more competitive
a decrease/depreciation in the real exchange rate
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.
What affects real exchange rate?
inflation (it rises when NZ inflation exceeds trading partners’ @ constant nominal rate - see equation)
nominal exchange rate increases
limits of purchasing power parity
goods not easily shipped or traded;
tradable goods are not perfect substitutes (ie different beers)
also services do not fall under this parity
effect of government budget deficit in a small open economy
no crowding out as reduction in savings is almost always offset by funds from abroad but investment does not change
trade policies affect micro or macro more?
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
effect of subsidy on exports or tax on imports
imports decrease, exports increase, this results in an increase in net exports -> increases demand for a country’s currency
promoting trade effects
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
