openness in the markets

Question 1

what is openness in the goods market ?

Answer 1

refers to the degree to which country’s engage in trade.

• in foreign goods bought from foreign countries
  and domestic goods bought by a foreign country

this is expressed as a % of GDP

the larger the % the more open the economy

Question 2

the uk is a very open economy, why are there arguments that we should be less open ?

Answer 2

it makes us very susceptible to shocks in other countrys

Question 3

what is the relationship between trade and domestic output ?

Answer 3

AD rises , Y rises

FOREIGN rises , Y falls

Question 4

when deciding whether or not to buy domestic or foreign goods/services consumers must consider the nominal ER. what is the nominal exchange rate ?

Answer 4

the price of domestic currency in terms of foreign currency.

Question 5

uk residents must be concerned about the cost of uk goods relative to their cost in euro currency.

this means that they must look at the real exchange rate, what is the real exchange rate ?

Answer 5

price of domestic goods in terms of foreign

3 = EP / P*

EP = price of domestic good in domestic currency x nominal ER

P* = price of euro area goods

Question 6

how do we use the real exchange rate ?

Answer 6

we consider the rate of change of 3 not actual 3 changes called depreciation or appreciation.

Question 7

what is an increase / decrease in the RER called ?

Answer 7

increase - appreciation

decrease - depreciation

Question 8

whats the problem with RER ?

Answer 8

its only Bi lateral and the uk has many main trading partners which we must consider to determine strength of currency.

Question 9

what is the REER ?

Answer 9

real effective exchange rate.

this is the value of domestic currency relative to value of ER of trading partners.

Question 10

what is the structure of the BoP ?

Answer 10

record of transfers with the rest of the world

comprised of 2 main accounts

current :

• X + M ( goods and services )
• recipes and payments of investment income
• unilateral transfers (gifts between economies )

capital :

• flows of investment across borders
• direct vs portfolio investment

Question 11

what issues are there with the bop accounts being in balance ?

Answer 11

there are measurement issues.

Question 12

if a country is running a current account deficit, how is it financed ?

Answer 12

. sell assets
. borrow money to finance
. use cb currency reserves - limited to keeping value of 3 months of imports

selling assets is most desirable

Question 13

when considering whether or not to hold foreign or domestic assets what do we consider ?

Answer 13

• we must confine to one asset class SR , IR bearing assets
• we must factor in the idea that foreign assets are affected by the nominal exchange rate
• domestic bond rates
• foreign bond rates
• current nominal exchange rate
• expected exchange rate in a year

Question 14

why do we use the UNCOVERED INTEREST PARITY CONDITION ?

Answer 14

if we use this it takes into account all the factors necessary into account and therefore helps us chose between foreign and domestic assets

Question 15

what reduces the expected rate of return on foreign financial assets ?

Answer 15

• expected appreciation of domestic currency

- or depreciation of foreign currency

Question 16

what is the UNCOVERED INTEREST PARITY CONDITION ?

Answer 16

no transaction costs
ignores risk and uncertainty

only usable when i and Xa are less than 20 %

it ss i*t - [ Eet+1 - Et / Et ]

domestic return - it
i*t - foreign return
[ Eet+1 - Et / Et ] - expected app of domestic or depp of foreign (Xa

Question 17

what happens in scenario 1 of the parity condition

where it > i*t - Xa ?

Answer 17

then the investors will invest into domestic bonds because the return is larger. thus funds will be flowing into the domestic bond market, until the parity is ss

Question 18

what happens in scenario 2 of the parity condition

where it < i*t - Xa ?

Answer 18

investors will chose foreign bonds

Question 19

what happens in scenario 3 of the parity condition

where it ss i*t - Xa ?

Answer 19

then investors are indifferent

Question 20

what is the full interest parity condition and when do we use it ?

Answer 20

used if i or Xa exceed 20%

1 + it = ( 1 + i*t ) / ( 1 + Xa )

Question 21

how is the IS relation different in an open market ?

Answer 21

zz = C + I + G + X - IM / 3

I’m - imports in terms of pounds

3 = exchange rate

Question 22

what are the equations for

a. imports
b. exports

Answer 22

a. IM = IM ( Y , 3 )
                 ( +, + )
b. X = X ( Y* , 3 )     
                 ( + , - )
exports are autonomous determined outside

Question 23

when imports are added to DD what happens to the curve ?

Answer 23

it becomes flatter because at higher levels of income you have to remove more imports

Question 24

what happens to the curve, after imports have been added, when exports are added ?

Answer 24

the curve is shifted up to become the ZZ curve .

Question 25

where on a graph with the zz and dd curves is trade balance ?

Answer 25

where they cross

Question 26

where is there a trade surplus or trade deficit on the dd and zz curve ?

Answer 26

at income below Ytb - surplus

at income beyond Ytb - deficit

Question 27

consider an increase in domestic demand, how does this effect the ZZ curve ?

Answer 27

consider gov increases G - income increases - output increases - and trade balance falls

• G increases - ZZ shifts up
• Y increases

and as Y2 is beyond where the original trade balance equilibrium is below it ( because the balance hasn’t adjusted yet )

it means there is a trade deficit

Question 28

what is different about the multiplier in an open economy ?

Answer 28

zz is flatter than dd which implies multiplier is smaller in open economy

in an open economy, an increase in Y not only satisfied by domestic goods but also an increase in imports

Question 29

consider an increase in domestic demand, how does this effect the ZZ curve ?

Answer 29

consider an increase in Y*

increase in total D*
increase in demand for X
shift of ZZ curve upwards

also shifts the whole NX as every level of domestic income exports are increased.

there is a trade surplus.

Question 30

what is coordination between countries of fiscal policy desirable ?

Answer 30

because when only one country implements fiscal policy it can lead to a larger Bop deficit, but is both countries coordinate it can mean that AD for both countries rises but the Bop stays the same

Question 31

why is there limited actual evidence of governments coordinating their fiscal policy ?

Answer 31

• some countries would have to do more than` others
• there is a high motivation to cheat/pull out of the deal
• may not have desired effect ( difficult to know marginal propensity to import/export)

Question 32

what are the home multiplier and foreign multiplier for the effect that fiscal policy has when countries trade a lot with each other ?

Answer 32

home = 1 / (1 - c1 + m/3)

foreign = 1 / (1 - c1 + m/3)

Question 33

how does the fiscal multiplier different in an open economy to a closed one ?

Answer 33

in an open econ the multiplier is lower than an closed economy

Question 34

what is the marshall lerner condition ?

Answer 34

the condition that when holds means that for a real depreciation net exports increases because exports have risen more than the value of imports ( IM/3)

Question 35

what is the J curve ?

Answer 35

it is a concept based on consumers imperfect knowledge and immobility.

when the exchange rate appreciates, the trade balance actually gets a lot worse because the value of imports increases and it takes consumers time to realise that their imported goods are more expensive and find alternatives.