Lecture 5 - The IS in the Open Economy

Question 1

What are the differences with a closed economy?

Answer 1

• Effect on trade balance. An increase in output leads to a trade deficit.
• Smaller effect of government spending on output. As ZZ is flatter than DD, the multiplier is smaller in the open economy.

Question 2

An increase in domestic demand leads to an increase in…

Answer 2

Domestic output but leads to also a deterioration of the trade balance.

Question 3

An increase in foreign demand leads to an increase in…

Answer 3

Domestic output and an improvement in the trade balance.

Question 4

What are the implications of increases in demand - domestic or foreign?

Answer 4

• Shocks to demand in one country affect all other countries.
• Economic interactions complicate the task of policy makers. Policy coordination is not so easy to achieve.

Question 5

What is the J curve?

Answer 5

The adjustment process in the trade balance in response to a real depreciation.

Question 6

A depreciation initially increases…

Answer 6

The trade deficit and, over time, exports increase and imports decrease, reducing the trade deficit.

Question 7

What is real appreciation?

Answer 7

An increase in the real exchange rate. Domestic goods are more expensive and there is a loss of competitiveness.

Question 8

What is real depreciation?

Answer 8

A decrease in the real exchange rate. Domestic goods are cheaper and there is a gain of competitiveness.