week 8 Flashcards
Optimal Currency Areas, Brexit and the Euro
closed economy is?
An economy that doesn’t interact with other economies in the world
So an open economy is?
Economy that interacts w other economies around the world.
~ by buying and selling both goods and services and assets (stocks and bonds etc.)
Exports + Imports are?
Exports:
- Goods & services that are produced domestically + sold/consumed abroad
Imports
- Goods and services that are produced abroad + bought/consumed domestically
Net exports (NX) are?
value of a nation’s exports minus the value of its imports
— also called the trade balance
factors that influence a country’s exports, imports and net exports: [6]
- Tastes of consumers for domestic & foreign goods
- Prices of goods at home and abroad
- Exchange rates
- People use domestic currency to buy foreign currencies
- Incomes of consumers at home and abroad
- Cost of transporting goods from country to country
- Government policies toward international trade
Net capital outflow (NCO) is?
NCO = purchase of foreign assets by domestic residents – purchase of domestic assets by foreigners
flow of capital takes two forms, those are?
- Foreign direct investment = You buy a BMW car factory
- Foreign portfolio investment = You buy shares in BMW
Factors that influence net capital outflow [4]
- Real interest rates paid on foreign assets
- Real interest rates paid on domestic assets
- Perceived economic and political risks of holding assets abroad
- Government policies that affect foreign ownership of domestic assets
Net exports should equal…?
Net capital outflow
NX = NCO holds as an accounting identity
IF NX > 0 it means there is a…?
TRADE SURPLUS
A Country is selling more goods and services to foreigners than it is buying from abroad.
From net sale of goods and services the country receives ______ CURRENCY
FOREIGN CURRENCY
- Which is a foreign asset (adds to NCO)
- May invest this abroad (still part of NCO!)
- So NCO=NX > 0
national accounts - open economy equations
- Open economy: Y = C + I + G + NX
- National saving: S = Y – C – G = I+NX
As NX=NCO, this implies
S = I + NCO
National savings = Domestic Investment + Net capital outflow
National savings = Domestic Investment + Net capital outflow means…?
when the UK saves a £ it can be used to accumulate capital at home or abroad
A trade surplus is when?
Exports > Imports and NX > 0
since Y = C + I + G + NX, what can we say about trade surplus?
S = I + NX
and **NCO = S-I > 0 **
since NX = NCO
—- Also note that I=S-NCO<S, i.e.,National Savings greater than investments
If instead NX<0 (trade deficit), then I=
I=S-NCO>S
National Savings less than investments (“foreigners do part”)
3 possible outcomes for an open economy?
- Trade Deficit
– X < M
– NX < 0
– Y < C + I + G
– Saving < Investment
– NCO < 0 - Balanced Trade
– X = M
– NX = 0
– Y = C + I + G
– Savings = Investment
– NCO = 0 - Trade Surplus
– X > M
– NX > 0
– Y > C + I + G
– Savings > Investment
– NCO > 0
Define nominal exchange rate
Rate at which a person can trade currency of one country for currency of another
define appreciation (strengthening)
increase in the value of a currency
(the amount of foreign currency one unit of the domestic currency can buy)
define depreciation (weakening)
decrease in the value of a currency
real exchange rate is the…?
the ratio at which a person can trade goods and services of one country, for goods and services of another
Formula for real exchange rate?
Real exchange rate of a Banana (example)
- Take a banana (UK vs US).
- Costs P pounds in the UK. Now exchange that amount of money into the foreign currency. We get e times P USD.
- Divide with the price of a banana in the US, P*, to get the number of bananas one can buy with the money.
- This is the real exchange rate: “How many US bananas is a UK banana worth”
Formula in letters of real exchange rate?
What do the letters of the formula for Real ER mean?
Using a price index (basket of goods):
☆ e – nominal exchange rate between the U.K. pound and foreign currencies
☆ P – price index for U.K. basket
☆ P* – price index for foreign basket
So (e × P) / P* is “the quantity of the basket of goods which a domestic unit of the basket can buy abroad”.
depreciation (fall) in the U.K. real exchange rate means?
☆ U.K. goods cheaper relative to foreign goods ☆
Consumers at home and abroad buy more U.K. goods and fewer goods from other countries
- Higher exports - Lower imports - Higher net exports
