Week 12 - Open Economy Markets

Question 1

What are the 3 dimensions of openess

Answer 1

1) openness in goods markets (fully open is free trade)
2) Openness in financial markets (free flow of financial assets)
3) openness in factor markets (firms choose where to locate production)

Question 2

What is the balance of payments

Answer 2

records of a country’s international trade, borrowing and lending, capital and investment flows

Question 3

What is the current account

Answer 3

records current (short-term) flows of funds in and out of a country

Question 4

Why is service exports the focus?

Answer 4

many developed economies are focusing on serice exports. Developing economies specialise in lower cost manufacturing which is more readily available while developed economies have an advantage in highly skilled, more expensive labour

Question 5

What is the net secondary income?

Answer 5

transfers made to residents of other countries - transfers received by Australians. This includes overseas aid, pensions and migrant’s funds.

Question 6

What is net primary income?

Answer 6

income received by Australian residents from investment in other countries - income paid overseas on investment in Australia.

Question 7

Why is net primary income persistently negative

Answer 7

Includes profits, dividends and interest repayments persistently negative in Australia as there is insufficient domestic savings leads to australians borrowing from abroad and foreign investment generates dividends and profits, which flow from overseas.

Question 8

What is the capital account?

Answer 8

records migrants’ asset transfers, debt foreign and sales/buying of non produced, non-financial assets.

Question 9

What is the financial account?

Answer 9

records purchases of physical and financial assets a country makes abroad and subtracts foreign purchases of these. Includes directs investment, portfolio investment, financial derivatives, RBA assets

Question 10

What do the balance of payment =

Answer 10

0

Question 11

What is the nominal exchange rate?

Answer 11

value of one country’s currency in terms of another

Question 12

formula for the real exchange rate?

Answer 12

real exchange rate = domestic price level/foreign price level

Question 13

What are 6 factors that can change the exchange rate?

Answer 13

1) changes in overseas demand for australian goods and services
2) changes in the desire to invest in Australia and Australian firms to invest overseas
3) changes in expectations of currency traders
4) changes in income and economic growth
5) changes in relative interest rates
6) speculation

Question 14

What is a freely floating exchange rate

Answer 14

determined entirely by the free market

Question 15

what is a fixed exchange rate?

Answer 15

value of currency is fixed against the value of another currency

Question 16

What is a managed exchange?

Answer 16

currency is allowed to float in a pre-defined rage, outside of which gov intervention is used

Question 17

What is the gold standard

Answer 17

National currency is redeemable in a certain amount of gold and all currencies adhered to a common standard.

Question 18

What is the impact of currency appreciation

Answer 18

1) revenue in au falls for exporters
2) exports fall for things whose prices is determined in Australia as price is higher
3) imports are cheaper
4) NX falls

Question 19

Define a flow

Answer 19

movement of real and financial resources across borders during a period of time

Question 20

Define a stock

Answer 20

accumulation of those flows at a points in time

Question 21

What does the AE model suggest about the international balance?

Answer 21

AE model and associated national income accounting suggests domestic savings that exceed domestic demand go overseas and vice-versa

Question 22

Define terms of trade

Answer 22

ratio of export to import prices, higher means earning more on each unit of exports than it pays for imports

Question 23

Formula for net foreign liability

Answer 23

net foreign debt + net foreign equity

Question 24

What happened with Japan’s gov debt

Answer 24

very high debt level but mostly owned by the Bank of Japan and private people in Japan. It doesn’t have to be repaid but it limited scope for spending.

Question 25

Why is fiscal policy less effective in open economies?

Answer 25

• if borrowing from domestic, interest rates rise
• if borrowing from global financial markets, there is little to no interest rate effect unless gov spending lead to higher inflation
• higher interest rates can lead to crowding out and less exports

Question 26

Why does monetary policy become more effective in open markets

Answer 26

• expansionary policy leads to interest rates being lower
• higher investment and consumption
• lower exchange rate
• higher net exports

Question 27

What are the three elements of the policy trilema

Answer 27

1) stable exchange rate
2) monetary policy autonomy
3) free financial flows

Question 28

What is the policy trilema

Answer 28

a country can only pick 2 of the 3 elements

Question 29

What were the Hawke-Keating reforms?

Answer 29

• until 1970’s Australia was relatively closed off
• stagflation hit and the active use of keynesian demand management
• tariffs were cut, the dollar was floated, commonwealth and quantas privatised and rba became independence

Question 30

What is the twin deficit hypothesis

Answer 30

high persistent public dissaving (G>T) would lead to a compensating borrowing from overseas in the form of a persistent trade deficit. Doesn’t match with Australia as we had budget surpluses and current account deficits.

Question 31

Why is the policy trilema a thing?

Answer 31

When a country fixes its exchange rate against the US dollar and is also open to foreign capital, if its central bank sets interest rates above those set by the Fed , foreign capital in search of higher returns would flood in. These inflows would raise demand for local currency , evenutally the peg with the dollar would break.

If interest rates are kept below those in America, capital would leave the country and the currency would fall.