Second half of 3b Macroeconomics of the Open Economy

Question 1

For a current account deficit (CAB < 0) what is happening in terms of what NZers are spending money on. What does this mean for the NCO?

Answer 1

New Zealanders are spending more on overseas goods, foreign services and current transfers than they are receiving from abroad. Foreigners will use this net income from NZ to purchase NZ assets (NCO < 0)

Question 2

For a current account surplus (CAB > 0), what is happening in terms of what NZers are spending money on. What does this mean for the NCO?

Answer 2

For a current account surplus (CAB > 0), New Zealanders are spending less on overseas goods, foreign services and current transfers than they are receiving from abroad. New Zealanders will use this net income from O/S to purchase foreign assets (NCO > 0)

Question 3

Where does the supply of NZD come from? Does this affect the NCO or CAB?

Answer 3

Supply of New Zealand Dollars: A positive value for the net capital outflow represents the quantity of dollars supplied for the purpose of buying foreign assets

Question 4

Where does the demand for NZD come from? Does this affect the NCO or CAB?

Answer 4

Demand for New Zealand dollars: The current account represents the quantity of dollars demanded for buying NZ’s net exports

Question 5

Why is the demand for NZD downward sloping?

Answer 5

An increase in the real exchange rate will make NZ exports more expensive for foreign buyers, and reduces the cost of goods imported from foreign countries and net exports will fall.

Question 6

What direction is the supply of NZD?

Answer 6

vertical

Question 7

Why is the supply of NZD vertical?

Answer 7

An increase in the exchange rate will decrease the cost of buying a foreign financial assets but it will also decrease the value of owning that asset → NCO does not depend on the real exchange rate (it is determined by the real interest rate)

Question 8

Does the supply of NZD come from NCO or net exports (affecting CAB?)

Answer 8

NCO

Question 9

Does the demand for NZD come from the NCO or net exports (affecting CAB?)

Answer 9

NX

Question 10

In the market for loanable funds, NCO is a component of _______

Answer 10

demand

Question 11

Why is NCO a component of demand in the market for loanable funds?

Answer 11

A person must finance the purchase of a foreign asset by obtaining the resources in the market for loanable funds
A capital inflow reduces demand for domestic savings for any quantity of domestic investment

Question 12

In the market for foreign currency exchange, NCO is the source of ________-

Answer 12

supply

Question 13

Why is NCO a source of supply in the market for foreign currency?

Answer 13

A person buying a foreign asset must supply dollars in order to exchange them into a foreign currency

Question 14

What is the key determinant of NCO?

Answer 14

real interest rate

Question 15

When NZ interest rate is high, foreigners _____ more NZ assets and therefore NCO______0

Answer 15

demand

Question 16

When NZ interest is low, domestic savers invest ________ and therefore NCO________0

Answer 16

abroad

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Question 17

What is the real interest rate?

Answer 17

the price of goods and services in the present relative to goods and services in the future

Question 18

What is the real exchange rate?

Answer 18

the price of domestic goods and services relative to foreign goods and services

Question 19

The two relative prices (real interest rate and real interest rate) determine what?

Answer 19

national savings, domestic investment, net capital outflow ad the current account balance

Question 20

What will an increase in business confidence do to the equilibrium in the economy?

Answer 20

• It will increase the demand for loanable funds.
• it will increase the domestic interest rates
• it will lead to a fall in NCO
• it will lead to a decrease in the supply of ND$ so the ER aprreciates

Question 21

What will an increase in export demand do to the equilibrium in the economy?

Answer 21

• it will increase the export demand which sees an increase in the demand for NZD thus appreciating the ER
• the balance payments identity is still maintained (CAB = NCO) and so only the FXMrkt changes, the others don’t change

Question 22

What is the effect of a government budget deficit on the equilibrium in the economy?

Answer 22

T < G which reduces national savings

• the supply of loanable funds falls
• this leads to an increase in interest rates
• quantity of loanable funds decreases
• increase in interest rate decreases the NCO (more attractive than investing abroad so capital inflow)
• NCO is reduces so the supply of NZD decreases
• the real exchange rate appreciates
• this means that exports fall and imports increase so NX falls

Question 23

What is a tariff?

Answer 23

A tax on an imported good

Question 24

What is an import quota?

Answer 24

A limit on the quantity of an import

Question 25

What do trade policies affect?

Answer 25

there is no affect on national savings, domestic investment, so there is no effect in the market for loanable funds, no change in the real interest rate and no effect on NCO

Question 26

What is the effect of an import quota?

Answer 26

An import quote increases the demand for NZD which causes the real exchange rate to appreciate.
This is the only market that is affected

Question 27

Why does an import quote lead to an appreciation of the real exchange rate?

Answer 27

Foreigners need dollars to buy NZ net exports, there is an increase demand for dollars in the market for foreign currency. This leads to an appreciation of the real exchange rate but there will be no change to the net exports.
The appreciation of the dollar in the FX market encourages imports and discouraged exports. This offsets the initial increase in net exports due to trade policy

Question 28

What is the effect of an increase in capital inflow on the equilibrium in the economy?

Answer 28

The increase in capital inflow leads to a decrease in the NCO due to an increase in inflow of foreign capital (it shifts to the left). This decreases the demand for loanable funds from savers in NZ which decreases the interest rate. At the same time, the decrease in NCO decreases the supply of NZD which causes the NZD to appreciate

Question 29

What is the effect of capital flight on the equilibrium in the economy?

Answer 29

Interest rates increase and the domestic currency depreciates