Open Economy Macroeconomics(Part 1) Flashcards
What is the balance of payments account?
-A country’s balance of payments accounts record a country’s international transactions with the rest of the world.
-The balance of payment accounts include the international sales(exports) and purchases (imports) of goods, services, and assets.
-The balance of payments account is broken into two key components:
1) Current account: The current account focuses on the movements of goods and services.
2) Financial account: The financial account focuses on the movements of assets.
How is the current account structured?
-The current account records the interantional flows of goods and services, and is structured as follows:
Net exports of goods (merchandise trade balance)
+ Net exports of services
+ Net factor income
+ Net international transfer payments
= Current account balance
What is net factor income?
-Net factor income has to do with our citizens working in other countries, being counted as an export, while other citizens working in our country is considered as in import.
-It relates to gross national product
What are net international transfer payments?
-These are net exports of goodwill.
-When we send aid to other countries, that is considered as an export, because we are sending something to other countries.
What transactions are recorded in the financial account?
-The financial account records the international flows of financial capital, including the payments we receive from selling our assets to them, as well as the payments we make from buying their assets.
-The financial account also shows the international transactions carried by not only the private sector, but also from the central bank.
-It also includes official reserves.
-FA=Exports of assets-Imports of assets
What are official reserves?
Official reserves are foreign assets held by the central bank.
When do capital inflows and capital outflows occur?
-Capital inflows occur when we sell or export assets to foreigners.
-Capital outflows occur when we buy or import assets from foreigners.
Briefly go through what goes into financial accounts and current accounts?
-Financial accounts covers outflows and inflows of goods
-Current accounts covers outflows and inflows of services
What does the balance of payments identity state?
-Current account plus financial account balance must equal zero.
-If one of these accounts have a surplus, the other account must have an equal deficit.
What are the key assumptions of the financial account?
1) It is a two country world, where there is the home(H0 and foreigner(F)
2) All the international capital flows are in the form of loans
3) It ignores the effects of the expected change in exchange rate on capital flows
4) There is perfect capital mobility and there is no risk premium
5) Net exports (NX)=net foreign investment
What are the three key implications with equilibrium in the lonable funds market?
1) The sum of all countries’ net exports must equal to zero. NX(H)+NX(F)=0
2) The sum of all countries’ international flows of capital must equal to zero. NFI(H)+NFI(F)=0
3) Domestic interest=Foreign interest=world interest
For an open economy, where does the supply and demand for loanable funds come from?
-SF=S National=S Private+S Public
-S National=I+NFI. or… NFI=S National-I
-Demand for loanable funds comes from domestic investment. DF=I(i)
What is the exchange rate?
The exchange rate is the price of one currency in terms of another country’s currency.
When E FC/DC increases or decreases, what does that mean?
-When E FC/DC increases, more foreign currency are needed to exchange one domestic currency, so domestic currency appreciates.
-When E FC/DC decreases, fewer foreign currency are needed to exchange one domestic currency. So domestic currency depreciates.
Where does demand for domestic currency come from? Where does supply of domestic currency come from?
-Demand for domestic currency comes from exports of goods, services, and assets.This happens because other countries must convert to local currency to buy from us.
-Supply of domestic currency comes from imports of goods, services, and assets, because Canadians convert their currency to foreign currency to make imports. That domestic currency they gave up is now supplied to the market.
Why is the demand for domestic currency downward sloping?
-The demand for domestic currency is downward sloping because when E FD/DC (domestic currency appreciates), domestic goods, services, and assets become more expensive. So domestic goods, services, and assets become more expensive. So foreigners buy less exports, and demand for domestic currency falls.
When does the demand for domestic currency shift?
1) Foreign output increasing: When foreign output increases, they can import more goods. That allows domestic exports to increase.
2) Capital inflows increasing: When domestic interest rate rises more quickly proportionate to international interest rate, domestic assets become more attractive which increases the demand for domestic funds.
3) Other factors that affect exports of goods, services, and assets. As exports increase, demand for domestic currency increase.
Why is the supply for domestic currency upward sloping?
-As the exchange rate increases and domestic currency appreciates, foreign goods/services become cheaper, so domestic consumers and businesses import more.
-When they make the imports, they supply domestic currency on the foreign exchange.
What factors can shift the supply of domestic currency curve?
1) Domestic output: When domestic output increases, domestic demand for foreign goods increases. The supply curve for domestic funds shifts right.
2) Capital outflows increasing: This occurs when domestic interest rate decreases proportionally to foreign interest rate.
3) Other factors that affect imports of goods, services, and assets.
What is nominal exchange rate? What is real exchange rate?
-Nominal exchange rate is unadjusted for the international difference in aggregate price levels.
-The real exchange rate is the exchange rate that does adjust for the international difference in aggregate price levels.
-RE FC/DC=E FC/DC*(P(H) * P(F)
-RE FC/DC=# of foreign goods/per unit of domestic goods
-The export level has to do with the real exchange rate.
What is the exports functions?
-X=X(0)-X(1)*E FC/DC
-X(0)=autonomous exports
-X(1)>0
What is the imports functions?
IM=IM(0)+IM(1)Y+IM(2)E FC/DC
-IM(0)=autonomous imports
-IM(1)=change in IM/change in Y=marginal propensity to import
-IM(2)>0
