Chapter 12

Question 1

what are our assumptions about the small open economy?

Answer 1

goods are perfectly integrated
goods produced in different countries are imperfect substitutes
financial markets are perfectly integrated
investors invest where ROI is highest
labour markets arent perfectly integrated - workers work and consume where they were born

Question 2

what is the nominal exchange rate?

Answer 2

price of domestic currency in terms of foreign currency

Question 3

what is the real exchange rate?

Answer 3

price of domestic goods in terms of foreign goods. with fixed mark ups its = RULC (relative unit labour cost)

Question 4

what does an increase in foreign income, domestic income lead to?

Answer 4

higher foreign leads to increase in exports so NX goes up
higher domestic leads to increase in imports so NX goes down

Question 5

whats the effect of an increase in the real exchange rate?

Answer 5

has negative effect of real exports, positive on real imports at same time imports become cheaper provided that price elasticities of import and export demand are sufficiently large, NX goes down when E appreciates which has a negative effect on AD

Question 6

what is the current account?

Answer 6

net lending of the country ( net claims on foreign countries) = income - savings - real investment of country as a whole

Change F = Y + rF - C - G - I
= NX + rF
net exports and net primary income from abroad (just interest income in our model)

Question 7

what does the open interest parity condition say? whats the approx

Answer 7

says the expected return should be the same on loans in different currencies:

1 + i* = 1 + i e^et+1/ et
it - i*t approx = -change e^Et+1/ et

Question 8

what happens if theres a credibly fixed exchange rate?

Answer 8

change in expected future currency = 0
i = i*
CB unable to control IR in SOE with fixed ER

Question 9

what happens with a floating exchange rate?

Answer 9

1 + it/ 1 + i* e^et+1

Question 10

what does a higher: interest rate, foreign IR, expected future currency lead to?

Answer 10

higher domestic i - appreciation of currency
higher foreign i - depreciation of currency
higher expected future currency - appreciation today

Question 11

what has happened to exports + imports in recent decades and why?

Answer 11

have increased relative to GDP after the deregulation of capital flows in 1970s and 80s current account surpluses + defecits have become larger relative to GDP. Globalisation in G+S markets and financial markets