Open Markets Flashcards
Openness in goods markets means…
- Lack of free trade restrictions including tariffs and quotas
- Low transport costs
Openness in financial markets means…
Lack of capital controls which place restrictions on the ownership of foreign assets
Openness in factor markets means…
The ability of firms to choose where to locate production, and workers to choose where to work
What is the real exchange rate?
The price of domestic goods relative to foreign goods
What affects the nominal exchange rate (E) in the S.R.?
S&D in the currency markets and it moves in the same direction an i
Real exchange rate =
EP/Pw
What affects the real exchange rate in the short run?
Due to sticky inflation moves with unanticipated changes in E
What is the law of one price?
Says that goods must sell for the same price in all countries in the long run due to arbitrage price convergence
What can cause the law of one price to not hold?
Differences in taxes, tariffs and transport costs
Nominal exchange rate with law of one price =
E = Pw/P
What is the real exchange rate in the Long run?
EP/Pw = 1, If the law of one price holds, then foreign goods and domestic goods should sell for the same price, so that the real exchange rate should equal 1
What is the nominal exchange rate in the long run?
Determined by the amount of money in one country relative to another as the quantity theory tells us that one of the key determinants of the price level is the money supply
Reasons for intratemporal trade:
Differences in preferences/productivity
Reasons for intertemporal trade:
Differences in patience, investment opportunities (ideas against cash)
Reasons for pure asset trade:
Differences in risk aversion, expectations about future
What does intertamporal trade allow for?
Risk-sharing where economies can trade to neutralize the impact of unanticipated shocks (to income, consumption, natural disaster etc.) in an attempt to smooth consumption
What is the Intertemporal budget constraint and why is it so?
PDV of the trade balance must = 0, because no one is willing to lend goods and services unless they will be repaid
When NX < 0 …
C + I + G > Y
What does financial market openness allow for?
Financial investors to diversify - to hold domestic & foreign assets and speculate on foreign interest rate movements
Countries to run trade surpluses & deficits - a country that buys more than it sells must pay for the difference from borrowing from the rest of the world
What is the balance of payments?
Account that summarises a country’s transactions with the rest of the world. The current account (trade balance) must be financed by inflow (borrowing) of capital.
What constitutes the current account?
Net exports (Exports & Imports) Net investment income & transfers
What constitutes the capital account?
Private investment Public investment (general government & reserve bank)
When is the capital account positive/negative?
Positive/negative if foreign holdings of domestic assets are greater/less than domestic holdings of foreign assets, in which case there is a capital account surplus/deficit
Domestic saving S =
(Y-T-C) + (T-G)
The trade balance =
The net capital outflow, which is equal to domestic saving minus investment
If a country runs a trade deficit…
it will invest more than it saves
The trade deficit is…
the additional borrowing done to finance the gap between investment and domestic savings
The net flow of goods associated with net exports is associated with…
a net flow of financial assets in the opposite direction - running a trade deficit is the same thing as having foreigners finance some of your investment
Why does China run trade surpluses?
It has so much domestic saving (exceeding investment) that it can ship goods abroad and invest more than foreigners invest in China.
What are net foreign assets?
The difference between foreign assets held domestically and domestic assets held abroad
What is the relationship between the budget deficit and the trade deficit?
The budget deficit and trade deficit move together most of the time
