Chapter 4. International Macroeconomics. Trade & exchange Flashcards
International trade
Situation today & outlook into the future
Since the financial crisis of 2008, international trade has been growing much more slowly.
Recently, the total volume of trade has also stagnated.
There are many reasons for this:
* No new ‘one-off effects’ such as China’s WTO accession in 2001
Liberalizations within the WTO have failed since Doha (Free trade agreements are only a second best).
* New trade barriers have been erected (non-tariff nature).
* The trade dispute between China and the US affects world trade.
In the future, technological advances could make in particular simple manual services (e.g. data processing) internationally tradable.
Drivers of international trade
Motivation: Possibility for arbitrage
Purchase and/or production of goods in one country at lower costs than the attainable price in another country (minus trading costs).
Obstacle; trading costs
* Transportation costs
* Customs duties
* Non-tariff trade barriers
Heckscher-ohlin model
“Heckscher-Ohlin Model
The country has a comparative advantage in terms of a good whose production requires the intensive input of a factor that is relatively abundant.
.
Examples
o China - worker
o USA - advanced pharmaceutical and chemical technology
Prebisch-Singer-Hypothesis:
Prebisch-Singer-Hypothesis:
Commodity prices fall over time, commodity exporters (often developing countries) receive an even smaller share of the trade profit
Stolper-Samuelson Theorem:
Stolper-Samuelson Theorem:
The relatively well available input, which determines the comparative advantage, is better compensated as a result of trading, the relatively poorly available input gets worse compensated - regardless of the industry!
Additional explanations for trade
- Differences in the comparative advantages and factorization explain a substantial part of trade.
- However, other factors play an important role in the composition and direction of trade flows:
Differences in preferences for a good between the countries
Trade restrictions such as duties, quotas, non-tariff trade barriers
Different technologies in the individual countries
Increasing economies of scale (size advantages) and imperfect competition (monopolistic competition) in individual industries - trade within the sector
Exchange rates formula
quotation exchange: extranjeros POV
Cuanto de su moneda necesitan par a1 de una moneda de aqui los otros/domestic currency
quantity exchange. nuestro pov, con nuestra moneda cuantas d la otra podemos comprar
domestic currency/extranjera
cual es el interest rate formula:
(1+ia)=(1+ib)E/Ee
depreciation
11.% que sea y te da
appreciation
regal de tres y lo que te de se lo restas al valor de la moneda que te hayan dicho (repasa)
types of exchanges
Nominal
Price of one currency in terms oppnother currency
Real (- Purchasing power of a curtency)
Price of currency adjusted for cross-country differences in prices of goods and service
Effective
Average exchange rate over several other currencies
Effective (Trade weighted)
When averaging, use amount of trade to weight the currency
check la definition buena y official para el effective weighted trade*!
Law of one price
Law of One Price
Y
* Identical commodities sell at same price no matter were they are sold
- Gas in Minneapolis, gas in St. Paul Big-Mac-Index
* Implies real rate = 1
Based on idea of arbitrage
Constraints of the Law of One Price:
* Transportation costs
US/Japan prices imply distance of thousands of miles.
*Border effects (tariffs, non-tradeables, etc.)
* Goods prices are “sticky”, nominal exchange rates aren’t
Pricing to market
*Exchange rate pass-through
Purchasing power parity
Purchasing power parity
* From the Law of One Price (which applies to individual goods), the purchasing power theory can be derived to determine the nominal and real exchange rate.
* If purchasing power is at parity, a freight basket can be purchased in different currencies for the same amount of money. Money has the same purchasing power over all countries
In purchasing power parity, the exchange rates are as follows:
y la formula* que check por q ??
Covered Interest Parity and Uncovered interest parity
Sure, let’s simplify covered interest parity (CIP) as much as possible:
Covered Interest Parity (CIP) Simplified
Basic Idea:
CIP is about making sure you don’t lose money due to changes in exchange rates when investing in another country’s financial products.
How It Works:
1. Two Interest Rates: You have interest rates from two countries: yours (domestic) and another country (foreign). 2. Exchange Rates: You deal with two exchange rates: * Spot Rate: The current exchange rate for immediate transactions. * Forward Rate: The agreed-upon exchange rate for transactions in the future.
Why Use CIP:
To avoid losing money from exchange rate changes when you invest abroad.
Steps:
1. Investing Abroad: Suppose you want to invest in another country because their interest rate is higher. 2. Currency Exchange: You need to convert your money to the foreign currency. 3. Future Planning: You don’t want to worry about exchange rates changing and potentially losing money when you convert back to your currency later.
CIP Solution:
You use a forward contract to lock in the exchange rate for the future. This contract specifies the rate at which you’ll convert your money back in the future.
Uncovered Interest Parity (UIP) Simplified
Basic Idea:
UIP is about making sure that investing in your country or another country gives you the same expected returns after considering potential changes in exchange rates.
How It Works:
1. Two Interest Rates: You have interest rates from two countries: yours (domestic) and another country (foreign). 2. Expected Exchange Rate: You consider what the exchange rate might be in the future (this is the “uncovered” part because you’re not using a forward contract to lock in the rate).
Why Use UIP:
To compare whether it’s better to invest in your country or abroad, considering possible changes in exchange rates.
Steps:
1. Interest Rates Comparison: You look at the interest rates of your country and the foreign country. 2. Future Exchange Rate Guess: You make an educated guess about the future exchange rate.
UIP Principle:
You should expect to get the same return from investing in either country, once you account for how the exchange rate might change. If one country offers a higher interest rate, its currency is expected to weaken, balancing out the higher return.
* Expected Future Exchange Rate: The rate you think will be in the future. * Current Exchange Rate: Today’s exchange rate. * Interest Rates: The rates at which you can earn interest in each country.
Example:
1. Your Interest Rate: 2% per year. 2. Foreign Interest Rate: 4% per year. 3. Current Exchange Rate: 1 domestic currency = 2 foreign currency units.
Formula:
current exchange rate (tu pov) *(1+your countrys interest rate)/(1+ su interest rate)
So, you expect that in the future, 1 domestic currency will be worth 1.9616 foreign currency units.
IS-LM model with international trade
If the foreign GDP rises, the foreign demand for all goods increases and a part of it is accounted for by goods from the domestic market.
* If the real exchange rate o rises. exports become more expensive.
Note: As exch. increases, domestic goods become more expensive and locals buy more foreign goods. Whether IM/e increases depends on the elasticity (-Marshall-Lerner condition).
Marshall-lenner condition
The Marshall-Lerner condition is an economic theory that states a country’s trade balance will improve following a depreciation of its currency if the combined price elasticity of demand for its exports and imports is greater than one. Specifically, it suggests that a devaluation (or depreciation) of a currency will lead to an improvement in the trade balance (i.e., an increase in net exports) if the sum of the absolute values of the demand elasticities for exports and imports exceeds one.
Mathematically, the condition can be expressed as:
|E_x| + |E_m| > 1
Where:
* E_x is the price elasticity of demand for exports. * E_m is the price elasticity of demand for imports.
The intuition behind the Marshall-Lerner condition is that if a currency depreciates, exports become cheaper for foreign buyers and imports become more expensive for domestic consumers. If the demand for both exports and imports is sufficiently elastic, the increase in the volume of exports and the decrease in the volume of imports will outweigh the effects of lower prices for exports and higher prices for imports, leading to an improvement in the trade balance.
Balance of payments
Definition and components
I
* The balance of payments covers the cross-border exchange of goods, services, labor, and capital income as iell as capital movements for a certain period.
. The development and structure of the balance of payments provide information on the foreign economic relations of a country.
. The methodological basis for the balance of payments statistics is the Balance of Payments Manual of the International Monetary Fund.
. The Swiss balance of payments consists of the following three balance sheets:
- Current account (formerly: profit and loss account)
- Asset transfers
- Capital and financial account (incl. Currency reserves of the National Bank)
Statistical difference
* The balance of payments transactions are posted twice, so that the balance of payments is in principle balanced.
In practice, however, this principle cannot be fully realized because of the diversity of exteral relations and data sources.
In the balance of payments, the statistical difference between the total “revenue side™ (performance account assumptions and capital imports) and the total of the
“expenditure side” (current account expenditures and capital exports) is referred to as statistical difference
Current account
* The current account is part of the balance of payments
* It contains the following partial balances
- Exports - Imports
- Investment income and dividends
- Net transfers
Capital and Financial Account
-Transactions in financial and nonfinancial assets
- Capital account
-capital transfers
- Financial account
-Net direct investment
-Net portfolio investment
-Net other investment
-Change in Reserve Assets
* Balance of Payments deficit or surplus
* Errors and omissions
-Fudge factor
-Statistical discrepancies of balance of payments
Expansionary sisal an monetary policy in an open economy
Fiscal Policy in the Open Economy
Effectiveness of Expansionary Fiscal Policy:
In an open economy, the effectiveness of expansionary fiscal policy (increasing government spending or reducing taxes) is influenced by several factors:
1. Keynesian Multiplier: The initial impact of government spending or tax cuts on the economy depends on the Keynesian multiplier. This multiplier effect is significant in determining the overall impact on economic output. 2. Leakages: In an open economy, some portion of the stimulus provided through fiscal policy may be lost to imports. This means that part of the additional income generated by the stimulus will be spent on foreign goods and services rather than domestic ones, reducing the overall impact on the domestic economy. 3. Imports and Exports: The additional demand generated by fiscal policy will lead to increased imports, as consumers and businesses purchase more foreign goods. The net effect on the economy depends on the balance between the increase in imports and the overall boost to domestic demand. 4. Example: The German car scrappage bonus, which aimed to boost car sales, primarily benefited the sale of small foreign cars. This demonstrates how fiscal stimulus can lead to increased imports.
Monetary Policy in the Open Economy
Effectiveness of Expansionary Monetary Policy:
Expansionary monetary policy in an open economy can have additional effects beyond lowering interest rates:
1. Exchange Rates: Lower interest rates can lead to a depreciation of the country’s currency. This happens because lower interest rates make holding that currency less attractive to investors, leading to a decrease in its value relative to other currencies. 2. Competitiveness: A depreciated currency makes the country’s goods and services cheaper for foreign buyers, potentially increasing exports. This can improve the country’s international competitiveness in the short run. 3. Depreciation Effects: The overall effect of currency depreciation can lead to a more competitive position for the country internationally, as its exports become cheaper and more attractive to foreign buyers. This is known as competitive devaluation.
IS-LM Model with International Trade:
The IS-LM model, which depicts the relationship between interest rates (I) and the output (Y) in an economy, can also be applied to open economies with international trade:
1. Global Uncertainty: During times of global uncertainty, such as a political crisis, investors may seek safe havens, often leading to an appreciation of certain currencies like the Swiss franc. 2. Transmission Mechanism: When investors move to safe havens, the demand for those currencies increases, leading to appreciation. This can negatively impact the country’s exports as their goods become more expensive for foreign buyers. 3. Economic Impact: The appreciation of a safe-haven currency can harm the short-term economic output of the country by reducing demand for its exports. This is depicted in the IS-LM model as a leftward shift of the IS curve, indicating reduced output at any given interest rate.
In summary, while both fiscal and monetary policies have significant roles in managing an open economy, their effectiveness is mediated by additional factors such as imports, exports, exchange rates, and international capital flows.
