The Open Economy Flashcards
If you produce less than what you buy
then your income Y is less than C + I + G so you have to borrow
If saving is
less than investment, they will be?
borrowing from abroad
In an open economy savings spending not equal to income and savings may not
equal
investment
Exports
are foreign spending on domestic goods
Imports are equal to
C – I – G
Net Exports =
= Y – C + I + G
this actually gives the global imbalance
NFI
Net foreign investment - which accounts for overseas
investors investing money into an economy and earning interest
If you take C and G out of the bracket in NX = Y – C + G + I, you get ___?
Ø There is perfect capital mobility which means?
Ø Economy is small – so cannot affect the world _____ – denoted as r*
Ø And since domestic bonds and foreign bonds are perfect ____ and
there is ______ so r = r*
NX = S – I,
no restrictions on trade on assets,
interest rate
substitutes, perfect capital mobility
Due to it being a small economy – if a fiscal policy at home is implemented
savings will move but interest rate will stay the same – this will just lower
the NX
If, however, the world adopts an expansionary fiscal policy this will lower
savings all over the world – which will lead to higher world interest rate
increasing the NX and investment will increase
so monetary policy does not affect
NX
Fiscal policy does affect the NX because it will
reduce or increase savings
Exchange does not affect NX
in the long run
e =
nominal exchange rate
nominal exchange rate
– the relative price of domestic currency in terms of
foreign currency
E
real exchange rate
E formula
=e x P/P* where P is domestic price and P* is foreign price
If real exchange increases that means the domestic goods are more ____ relative to ___ goods and so people buy ______. So ____fall, and ____ increase – NX ____.
expensive, foreign, less of it. Exports, Imports, falls
As we know from the demand equation it shows that ______. exchange rate may
change the ___ but until left hand-side changes the right side ______. so in
the long-run __ comes back to ____
S – I = NX
NX
will not change
NX, S-I
Savings - Investment(S-I) What are they determined by
Savings is determined by domestic factors such as output, fiscal policy and policy
variables
Ø Investment is determined by the world interest rate
Expansionary fiscal policy will lead to a fall in savings – leading to an
increase in the real exchange rate and lower NX
If the rest of the world is running an expansionary fiscal policy – this will
cause the real interest rate to increase
Ø This will increase the net capital outflow and the supply of the dollar in
the foreign exchange market so NX increases
Increase in investment demand – will reduce____ – so
the currency becomes scarcer and so prices for it ___– real
exchange rate increases
the net capital outflow, increases
Trade policy – if import is restricted – this will increase NX – so the
demand for the dollar shifts to the right
Ø There will be no change in net exports as in the long run it will shift back
to the original point
Ø This policy does not affect S and I so supply will remain the same
Monetary policy can only change the nominal exchange rate
through changing the
inflation rate
PPP
A doctrine that states that goods must sell at the same (currency-adjusted)
price in all countries
