Transcript Ch5

Ch 5
The Open Economy
Mankiw: Macro Ch 5 and Appendix
Mankiw: Econ Ch31, Ch32
1
Outline
accounting identities for the open economy
 the small open economy model
 what makes it “small”
 how the trade balance and exchange rate are
determined
 how policies affect trade balance & exchange rate

2
Open and Closed Economies
A closed economy 封閉的經濟體系：
one that does not interact with other economies:
no exports, no imports, no capital flows.

An open economy 開放的經濟體系：
one that interacts with other economies around the world.
1. buys/ sells goods & services in world product markets:
International flow of goods.
2. buys/ sells capital assets in world financial markets:
International flow of financial resources.

3
1. The International Flow of Goods
Exports (EX，出口)：goods & services
produced domestically and sold abroad.
 Imports (IM，進口)：goods and services
produced abroad and sold domestically.


Net exports (NX，淨出口)
or trade balance (TB，貿易淨額)：
NX=EX-IM
4
The Flow of Goods
Net exports or Trade balance：
(1) NX=0，EX=IM：balanced trade 貿易平衡
(2) NX > 0，EX > IM：trade surplus 貿易盈餘
(出超)
(3) NX < 0，EX < IM：trade deficit 貿易赤字
（入超）
5
Trade-GDP ratio, selected countries, 2004
(Imports + Exports) as a percentage of GDP (%)
Luxembourg
275.5
Germany
71.1
Ireland
150.9
Turkey
63.6
Czech Republic
143.0
Mexico
61.2
Hungary
134.5
Spain
55.6
Austria
97.1
United Kingdom
53.8
Switzerland
85.1
France
51.7
Sweden
83.8
Italy
50.0
Korea
83.7
Australia
39.6
Poland
80.0
United States
25.4
Canada
73.1
Japan
24.4
6
Taiwan data: Trade-GDP ratio
Taiwan (%)
EX/Y
IM/Y
(EX＋IM)/Y
歷年平均
38.16
36.51
74.67
1951-1960
9.42
15.65
25.07
1961-1970
20.81
22.91
43.72
1971-1980
45.60
43.98
89.59
1981-1990
52.17
42.26
94.42
1991-2000
46.50
44.30
90.79
2001-2007
61.43
55.74
117.17
7
Taiwan data: NX=EX-IM
Fig
出口與進口佔GDP比例（%）
80
70
60
%
50
出口比例
40
進口比例
30
20
10
0
1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005
年度
8
U.S. net exports, 1950-2006
2%
0
0%
-200
-2%
-400
-4%
-600
-6%
-800
1950
-8%
1960
1970
NX ($ billions)
1980
1990
percent of GDP
billions of dollars
200
U.S. Net Exports, 1950-2006
2000
NX (% of GDP)
9
GDP: expenditure approach
C C
d
C
d
I I I
f
f
G G d G f
superscripts:
d = spending on
domestic goods
f = spending on
foreign goods
EX = exports
= foreign spending on domestic goods
IM = imports = C f + I f + G f
= spending on foreign goods
NX = net exports (trade balance)
= EX – IM
10
GDP: expenditure approach
Y  C d  I d  G d  EX
f
f
f
 (C  C )  (I  I )  (G  G )  EX
 C  I  G  EX  (C f  I f  G f )
 C  I  G  EX  IM
 C  I  G  NX
11
Accounting identities
Y = C + I + G + NX
or,
NX = Y – (C + I + G )
domestic
spending
net exports
output
12
Factors that Affect NX
(1) Tastes of consumers for domestic & foreign goods.
(2) The incomes of consumers at home and abroad.
(3) The prices of goods at home (P) and abroad (PF).
(4) The exchange rates (匯率，e) at which people can
use domestic currency to buy foreign currencies.
(5) The costs of transporting goods from country to
country.
(6) The policies of the government toward international
trade.
13
2. The Flow of Financial Resources

Net capital outflow (NCO)，淨資本流出：
purchase of foreign assets by domestic residents
minus purchase of domestic assets by foreigners.
A Taiwanese buys stock in the US corporation
 Capital outflow （$流出）
 a US citizen buys Taiwan stock.
 Capital inflow （$流入）
Net capital outflow =capital outflow –capital inflow
（$淨流出）

14
Factors that Influence NCO
(1) real interest rates (rF) being paid on foreign assets.
real interest rates ( r ) being paid on domestic assets.
 the differences ( r- rF ) matters
As r↑ relative to rF
 less capital outflow and more capital inflow
 NCO↓
(2) The perceived economic and political risks of holding
assets abroad.
(3) The government policies that affect foreign
ownership of domestic assets.
15
S, I and NX

Expenditure approach of GDP:
Y = C + I + G + NX

Income approach of GDP:
S= Y-C-G
→ S =Y-C-G = I + NX (Identity)
16
S, I and NCO
Saving S = △wealth
(wealth: deposits/bonds/stocks/houses)
= △domestic assets + △foreign assets
= domestic investment +net capital outflow
= I + NCO
 An economy’s saving can be used to either
finance investment at home or to buy assets abroad.

17
The Equality of NX and NCO
National saving (S):
S = I + NX or S= I + NCO
 NX = NCO


When S > I, NX=NCO>0, country is a net lender
When S < I, NX=NCO<0, country is a net borrower
補充：
國際收支帳＝經常帳＋資本帳（小）＋金融帳
經常帳 ：包含NX
金融帳 ：包含這裡的NCO
 簡化分析
18
Taiwan data: S-I=NX
Fig 31.2a
國民儲蓄與投資比例
45
40
35
30
25
%
國民儲蓄比例
投資比例
20
15
10
5
0
1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005
年度
19
Taiwan data: NCO=NX
Fig 31.2b
NCO比例(%)
25
20
15
%
10
NCO比例
5
0
1951 1954
1957 1960 1963
1966 1969 1972
1975 1978
1981 1984 1987
1990 1993 1996
1999 2002
2005
-5
-10
年度
20
The Prices for International Transactions:
Real and Nominal Exchange Rates
International transactions are influenced by
international prices.
 The nominal exchange rate 名目匯率 ：
the rate at which a person can trade the currency of
one country for the currency of another.
貨幣的價格（以另一種貨幣表示 ）

21
Nominal Exchange Rates


The nominal exchange rate （e）
is expressed in two ways:
(1) in units of foreign currency (FE) per one Taiwan
dollar.
(2) in units of Taiwan dollars per one unit of the foreign
currency.
Assume the exchange rate between the NT$ and U.S.
dollar is NT$30.3 to one U.S.dollar.
(1) NT$1 trades for 1/30.3 (= 0.033) of a U.S. dollar.
(2) One U.S. dollar trades for NT$30.3 採用
22
Nominal Exchange Rates
Appreciation 升值:
an increase in the value of a currency as measured by
the amount of foreign currency it can buy.
 Depreciation 貶值: a decrease
eg,
(1)US$1=NT$33  NT$30 （美金貶值）
NT$1=US$(1/33)  US$(1/30)：台幣升值
(2) US$1=NT$33  NT$35：台幣貶值(美金升值)

23
年度
20
20
19
19
19
19
19
19
19
19
19
19
19
19
19
19
05
02
99
96
93
90
87
84
81
78
75
72
69
66
63
60
美金匯率
Taiwan data: 台幣對美金匯率
台幣對美金匯率（1960-2007年資料）
45
40
35
30
25
20
15
10
5
0
美金匯率
24
匯率換算
2008/10/29
US$1=日圓$97
US$1=NT$33.3
日圓$97=US$1=NT$33.3
日圓$1=NT$0.34
(NT$1=日圓$2.91)
25
Real Exchange Rates
The real exchange rate 實質匯率(ε):
the rate at which a person can trade the goods and
services of one country for the goods and services of
another.
P
Y
 X
X
PY
X  Q : domestic goods
Y  QF : foreign goods

The real exchange rate
compares the prices of
domestic goods and foreign
goods in the domestic
economy.
26
Real Exchange Rates

The real exchange rate depends on
the nominal exchange rate and the prices of goods in the two
countries measured in local currencies.
Real exchange rate
QF
foreign goods

domestic goods
Q
Domestic price

Foreign price  Nominal exchange rate
P

ePF

27
Real Exchange Rates

If a case of Taiwan beer is NT$30,
a case of American beer is US$0.5,
and e =30,
QF
P
30



2
Q
ePF 30 * 0.5
P  2(ePF ) or QF  2Q
A case of Taiwan beer is twice as expensive as American beer.
Or the real exchange rate is 2 cases of American beer per case
of Taiwan beer.
28
Real Exchange Rates
The real exchange rate is a key determinant of
how much a country exports and imports.
(real exchange rate = terms of trade 貿易條件)
 A depreciation (fall) in Taiwan real exchange rate: 貶值
ε↓ =(P/ePF) ↓ ，due to P ↓or PF↑ or e↑
 Taiwan goods have become cheaper relative to foreign
goods.
 IM ↓ and EX ↑
 NX ↑

29
U.S. net exports and the
real exchange rate, 1973-2006
140
Trade-weighted real
exchange rate index
2%
120
NX (% of GDP)
1%
100
0%
-1%
80
-2%
60
-3%
-4%
40
Net exports
(left scale)
-5%
20
-6%
-7%
1973
0
1977
1981
1985
1989
1993
1997
2001
2005
30
Index (March 1973 = 100)
3%
An Open Macro Model
Ch5 open macro model:
3 markets and 2 prices to assure general equilibrium:
(1) LF market: S(r) = I(r)+NCO(r)  r*
(2) Market for Foreign-Currency Exchange (FE):
NCO(r)=NX(ε) ε*
(3) Goods market:本期K外生，L給定或固定，
Y(LR) is determined by the supply side. Y=AF(K, L)
而r* C, S, I, andε*NX:即決定Yd成分＊
＊no labor market, no money market, if have, PPP:MP
＊LF and FE市場均衡，隱含商品市場也均衡，故著重前兩個市場
的分析。
31
An Open Macro Model

Key macro variables:
 national saving: S
 investment: I
 net exports：NX
 net capital outflow：NCO (課本CF)
 real interest rate: r
 nominal exchange rates：e

real exchange rates： ε ≡ (P/ePF).
32
Large Open Economies (Appendix)
Basic Assumptions

Takes GDP (Y and YF) as given (exogenous)
排除Y對IM的影響，排除YF對EX的影響
Takes price level (P and PF) as given:
Nominal and Real exchange rate: 1-1對應

eg, 台幣升值 e↓ <＝> ε≡ (P/ePF) ↑
 Assume perfect capital mobility:
no restrictions on international capital flows
And assume domestic & foreign bonds are perfect substitutes
(same risk, maturity, etc.)
_ r is determined in the LF market.
33
Markets for Loanable Funds (LF)
S = I + NCO
 Supply of LF：SLF＝S
Demand for LF：DLF＝I+NCO
domestic investment and net capital outflows
(net foreign investment).
 The price in LF market is the real interest rate,
r=R-π.
34
LF Market

SLF =S： (+)vely-slpoed，
Assume SE >IE, so r ↑→ S ↑

DLF=I+NCO： (-) vely-slpoed，
As r ↑, I↓, NCO↓(r↑ relative rF )

Market equilibrium:
The interest rate adjusts to bring supply and demand for
loanable funds into balance.
35
Fig 5-15
How Net Capital Outflow Depends on the Interest Rate
Real
Interest
Rate
NCO
Net capital outflow
is negative.
0
Net capital outflow
is positive.
Net Capital
Outflow 36
Copyright©2003 Southwestern/Thomson Learning
Figure 5-17 The Market for Loanable Funds
Real
Interest
Rate
SLF=S
r*
DLF=I+NCO
LF*
Quantity of
Loanable Funds
37
Copyright©2003 Southwestern/Thomson Learning
Market for Foreign-Currency Exchange (FE)
Assume FE =U.S. dollars
 For an economy as a whole,
NCO = NX
 equilibrium condition of FE market
The price in FE market is the real exchange rate
(P/ePF).
 課本圖形為對美金（本國貨幣）供需，
在此採用該圖形則為本國貨幣「台幣」的供需
38
FE Market
DFE= NX： (-) vely-slpoed ，
As ε =(P/ePF) ↓, EX↑, IM↓, NX↑
NX↑: demand for NT$↑ in terms of US$
( 出口賺美金，將美金兌換為台幣，為台幣需求DFE= DNT)

SFE =NCO： vertical，
NCO：由 r 與 rF 差異決定，
unrelated to the real exchange rate.
( 為購買美國資產，將台幣兌換為美金，為台幣供給SFE = SNT )


Market Equilibrium:
The real exchange rate adjusts to balance supply and demand for
dollars.
39
Figure 5-18
The Market for Foreign-Currency Exchange
Real
Exchange
Rate
SFE=SNT＝NCO
Equilibrium
ε *=(P/ePF)*
DFE=DNT＝NX
Q*NT
Quantity of NT Dollars
In terms of US dollar
40
Copyright©2003 Southwestern/Thomson Learning
FE Market


At ε*=(P/ePF)*, 同時決定 e* ( given P and PF)
DNT from net exports exactly balances
SNT to be exchanged into foreign currency to buy assets abroad.
Alternative(補充)：
也可以以外匯（美金）供需做圖，最終推論相同。
美金供需決定美金價格（匯率）
一體兩面：對台幣需求＝對美金供給
對台幣供給＝對美金需求
Consider NX↑ : D-S analysis  ε*↑ and e*↓
41
Fig Alternative representation (僅供參考，課堂不採用):
The Market for Foreign-Currency Exchange
Nominal
Exchange rate
(e)
Demand for US dollars
(NCO)
Supply of US dollars
(NX)
Equilibrium
e*
Equilibrium
quantity
Quantity of FE
(US dollars)
42
Copyright©2003 Southwestern/Thomson Learning
Equilibrium in the Large Open Economy
Fig 5-19: Equilibrium in the Open Economy

NCO links LF market and FE market. (圖b)

r in LF market (圖a) and ε in FE market (圖c)
adjust simultaneously to achieve equilibrium
in these two markets.

As they do, they determine the macro variables of S, I, NX,
and NCO.
補充：r, ε(e), S, I, NX, NCO：endogenous 內生變數
43
Figure 5-19 The Real Equilibrium in an Open
Economy
(a) The Market for Loanable Funds
Real
Interest
Rate
(b) Net Capital Outflow
Real
Interest
Rate
SLF=S
r
r
DLF=I+NCO
Net capital
outflow, NCO
Quantity of
Loanable Funds
Net Capital
Outflow
Real
Exchange
Rate
SNT
ε1
DNT
Quantity of
NT Dollars
(c) The Market for Foreign-Currency Exchange
44
Copyright©2003 Southwestern/Thomson Learning
Comparative Statics

The magnitude and variation in open macro variables
depend on:
1. Government budget deficits
2. Trade policies
3. Political and economic stability
45
1.
Government Budget Deficits:
Sg < 0  S↓
(圖a) In an open economy, government budget deficits (Sg < 0)
reduce the supply of LF market：
S↓ SLF ↓  r*↑
 I↓ and NCO↓
 (圖b) Movement along with NCO curve
(圖c) Effect on FE Market
NCO↓ SFE ↓: shifts to the left
 real exchange rate↑（課本符號 ε↑）：升值
and also e*↓ (升值，P, PF as given )
ε↑  NX↓
eg, Twin deficits (1980s US: Sg<0 and NX<0)
46
Fig 5-20 The Effects of Government Budget Deficit
(a) The Market for Loanable Funds
Real
Interest
Rate
r2
S
1. A budget deficit reduces
(b) Net Capital Outflow
the supply of loanable funds . . .
Real
Interest
Rate
S
B
r2
A
r
r
3. . . . which in
turn reduces
NCO
2. . . . which
Increases r
D
NCO
Quantity of
Loanable Funds
Net Capital
Outflow
Real
Exchange
Rate
ε
ε
2
5. . . . which
causes the
real exchange
rate to
appreciate.
S
S
4. The decrease
In NCO reduces
the supply of dollars
to be exchanged
into foreign
currency . . .
1
D
Quantity of
NT Dollars
47
(c) The Market for Foreign-Currency Exchange
Copyright©2003 Southwestern/Thomson Learning
2. Trade Policy 貿易政策

A trade policy is a government policy that directly
influences the quantity of goods and services that a
country imports or exports.
Tariff 關稅: A tax on an imported good.
 Import quota 進口配額: A limit on the quantity
of a good produced abroad and sold domestically.

48
Trade Policy: Effect of an Import Quota
Effect of an Import Quota
(圖a, b) S , I, and NCO: unaffected  r*：the same
(圖c) Initial IM↓  NX↑= DE↑: shifts to the right
 the real exchange rate to appreciate.
 NX↓( movement along DE2) = initial NCO
This offsets the initial increase in net exports due to import
quota.

Trade policies do not affect the trade balance.
Trade policies have a greater effect on microeconomic than
on macroeconomic markets.
49
Fig 5-22 The Effects of an Import Quota
(a) The Market for Loanable Funds
Real
Interest
Rate
(b) Net Capital Outflow
Real
Interest
Rate
S
r
r
3. NX
however, remain
the same.
D
NCO
Quantity of
Loanable Funds
Net Capital
Outflow
Real
Exchange
Rate
2. . . . and
causes the
real exchange
rate to
appreciate.
ε
Supply
1. An import
quota increases
D fo NT
dollars . . .
2
ε1
D
D
Quantity of
Dollars
50
(c) The Market for Foreign-Currency Exchange
Copyright©2003 Southwestern/Thomson Learning
3. Political Instability and Capital Flight
資金外逃金融危機
When an economy faces political instability,
capital flight may happen:
a large/ sudden reduction in D for the country’s assets .
eg, 1994 Capital Flight in Mexico
1997 Capital Flight in East Asia
 Capital is fleeing：NCO↑
(圖b, a) NCO↑ DLF↑ r*↑

(圖b ,c) NCO↑ SFE↑ ε* ↓ e*↑
(the domestic currency depreciates.貨幣大幅貶值)
51
Fig 5-23b The Effects of Capital Flight
(課本5-23：NCO是左移的例子)
(a) The Market for Loanable Funds in Mexico
Real
Interest
Rate
(b) Mexican Net Capital Outflow
Real
Interest
Rate
S
r2
r2
r1
r1
3. . . . which
increases
the interest
rate.
1. An increase
in NCO
D2
D1
NCO1
Quantity of
2. . . . increases the demand
Loanable Funds
for loanable funds . . .
NCO2
Net Capital
Outflow
Real
Exchange
Rate
5. . . . which
causes the
peso to
depreciate.
ε1
ε2
S
S2
4. At the same
time, the increase
in NCO
increases the
supply of pesos . . .
D
Quantity of
Pesos
52
(c) The Market for Foreign-Currency Exchange
Copyright©2003 Southwestern/Thomson Learning
Samll Open Economy:
additional assumption regarding capital flows
 Small economy cannot affect the world interest rate,
 r is exogenous, r= r* (r*:the world real interest rate)
 NCO= S(r*)- I(r*)
Only real exchange rate is determined in the FE market: ε*
 課本NX= S - I(r*)，
供需觀點，NCO較正確:Fig5-16(b): NCO is perfectly elastic at world r*.
 課本圖：Assume S is not a function of r
S is vertical. NCO= S - I(r*)
* The main results are not affected
even if S is assumed to be positively-sloped.
53
A small open economy: LF market
the exogenous world
interest rate r*
determines I
r
S
NCO1
r*
…and the difference
between S and I
determines NCO
rc
I (r )
I1
S, I
54
FE market equilibrium:ε*
ε
S I 1(r*)
ε1
NX(ε )
NCO1
NT$
55
Comparative statics
1. Fiscal policy at home
2. Fiscal policy abroad
3. An increase in investment demand
4. Trade policy to restrict imports
56
1.
Fig 5-3, 5-9:
Expansionary Fiscal policy at home
r
An increase in G or
decrease in T
reduces saving.
S2 S1
NCO2
r
*
1
Results:
I  0, NCO  S  0
NCO1
I (r )
I1
S, I
57
1.
Expansionary Fiscal policy at home:
ε*↑(升值) and NX↓
S 2  I (r *)
ε
S 1  I (r *)
ε2
ε1
NX(ε )
NCO 2
NCO 1
NT$
58
NX and the federal budget deficit
(% of GDP), 1960-2006
4%
8%
Budget deficit
(right scale)
2%
6%
4%
0%
2%
-2%
0%
-4%
Net exports
(left scale)
-2%
-6%
-4%
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 59
slide 59
2. Fig 5-4, 5-10:Fiscal expansion abroad
Expansionary
fiscal policy
abroad raises
the world
interest rate.
r
NCO2
r2*
S1
NCO1
r
*
1
Results:
I  0
I (r )
NCO  I  0
I (r )
*
2
I (r1* )
S, I
60
2. Expansionary Fiscal policy abroad:
ε* ↓(貶值) and NX ↑
ε
S 1  I (r1 *)
S 1  I (r2 *)
ε1
ε2
NX(ε )
NCO 1
NCO 2
NT$
61
3. Fig 5-5, 5-11:
An increase in investment demand
r
Results:
△I > 0,
△S = 0,
△NCO= -△I <0
S
NCO2
r*
NCO1
I (r )2
I (r )1
I1
I2
S, I
62
3.
Increase in investment demand:
ε*↑(升值) and NX↓
ε
S1  I 2
S1  I 1
ε2
ε1
NX(ε )
NCO 2
NCO 1
NT$
63
4.
Fig 5-12:
Trade policy to restrict imports
At any given value of ε,
an import quota
 IM   NX 
 demand for
NT dollars shifts
right.
ε
ε2
Trade policy doesn’t affect ε
S or I , so capital flows and
the supply of NT dollars
remain fixed.
Results:
ε > 0, NX = 0,
IM < 0, EX < 0
S I
1
NX (ε )2
NX (ε )1
NCO1
NT$
64
A fiscal expansion in three models
A fiscal expansion causes national saving to fall.
The effects of this depend on openness & size:
closed
economy
large open
economy
rises
rises, but not as much
as in closed economy
no
change
I
falls
falls, but not as much
as in closed economy
no
change
NX
no
change
falls, but not as much as in
small open economy
falls
r
small open
economy
65
CASE STUDY:
The Reagan deficits revisited
1970s
1980s
actual
change
closed
economy
small open
economy
G–T
2.2
3.9



S
19.6
17.4



r
1.1
6.3


no change
I
19.9
19.4


no change
NX
-0.3
-2.0

no change

ε
115.1
129.4

no change

Data: decade averages; all except r and ε are expressed as a percent of GDP;
ε is a trade-weighted index.
66
Determinants of the nominal exchange rate

Definition for the real exchange rate:
P

e  PF

Solve for the nominal exchange rate:
P
e
  PF
67
Determinants of the nominal exchange rate
P
e
  PF

So e depends on the real exchange rate and the price levels at
home and abroad…
 : NX ( )  NCO(r*)  S (r*)  I (r*)
P:
M
 L ( r *  , Y )
P
MF
PF :
 L(rF *  F , YF )
PF
68
Determinants of the nominal exchange rate
P
e
  PF

in growth rates
e P PF 




 (   F ) 
e
P
PF




For a given value of ε, the growth rate of e equals the
difference between domestic and foreign inflation rates.
The higher the domestic inflation rate, the greater the
depreciation of domestic currency.
69
Inflation differentials & nominal exchange rates
35
Percentage
30
change in
nominal 25
exchange
20
rate
15
Mexico
Iceland
Singapore
10
South Africa
Canada
5
South Korea
_
0
U.K.
Japan
-5
-5
0
5
10
15
20
25
30
Inflation differential
70
LR Theory of Exchange -Rate Determination:
Purchasing-Power Parity Theory （PPP theory）

The simplest and most widely accepted theory explaining the
variation of currency exchange rates.

PPP theory 購買力平價說：
a unit of any given currency should be able to buy the
same quantity of goods in all countries
(same purchasing power).
LR equilibrium theory
71
Purchasing Power Parity (PPP)

For one unit of goods: same price

Solve for e :
e PF = P
e = P/ PF

PPP implies that the nominal exchange rate between
two countries equals the ratio of the countries’ price
levels.
72
Logic of PPP: （隱含ε=1）
NT$1
= able to buy the same quantity of goods in all countries.
=(1/P) unit of goods in Taiwan
=(1/e)/PF unit of goods in foreign country
 1/P= 1/ePF  P/ePF =1
 
QF
P

1
Q e  PF
P  (e  PF ) or QF   Q
73
Logic of PPP

PPP based on the law of one price.
（競爭）整合市場的單一價格
According to the law of one price, a good must sell for the
same price in all locations.
 If the law of one price were not true, unexploited profit
opportunities would exist.
 arbitrage.套利：the process of taking advantage of
differences in prices in different markets.
 eventually prices that differed in two markets would
necessarily converge. 收斂

74
Implications of PPP
According to PPP, P/ePF =1
 Exchange rates move to ensure that in the LR.
（LR equilibrium exchange rate: e*）

P/ePF =1  e* = P/PF
e* must reflect the different price levels in two countries.

Table 5-2: 2005年Big Mac在美價格美金3.06元，在台灣為新台幣75.4元。
即美金值 24.6台幣。(但實際匯率為31.3)
P=NT$75.4, PF =US$3.06
 e* = P/PF =NT$75.4/US$3.06= NT$24.6/US$
75
Arbitrage 1: price adjustment
If real exchange rate = P/ePF <1
P < ePF
Arbitrage 1：
P < ePF _ EX↑, IM↓

demand for domestic goods↑& demand for foreign goods↓
Possible that P↑ or PF ↓,
 so that P=ePF, NX=0

76
Arbitrage 2:
The nominal exchange rate adjusts to equalize the cost
of a basket of goods across countries.
If real exchange rate = P/ePF <1
(1) P<ePF  NX>0  demand for NT$↑
 e*↓(升值)
(2) 若未升值，但預期升值，則
熱錢流入(Arbitrage): buy NT$ and sell it later.
US$1  NT$33  US$ (33/28) = US$1.18
As demand for NT$↑, the value of NT$↑  e*↓


民74年以前，1美元兌換新台幣36-40元左右。由於國際美元走弱及中
美貿易逆差擴大，美國開始壓迫我國新台幣升值，中央銀行採緩慢升
值方式，因而導致國外熱錢大量流入國內。78年元月，新台幣收盤價
為28元兌1美元。
77
Implications of PPP
LR: P depends on Ms ；PF depends on MFs
△e*
例如： M↑ P↑
依據PPP ( e* = P/PF) …  e*↑（貶值）
When CB prints large quantities of money,
the money loses value both
in terms of goods it can buy and
in terms of the amount of other currencies it can
buy.
 the currency depreciates relative to other currencies.
78
Implications of PPP
1. PPP較鬆的條件：1改為常數
ε = P/ePF = c, e = P/ (εPF )= P/cPF

e P PF
0


  F

e
P
PF

2. 與之前e決定的公式相比：此處指貿易條件不變，即   0


亦是For a given value of ε, the growth rate of e equals the difference
between domestic and foreign inflation rates.
The higher the domestic inflation rate, the greater the depreciation of
domestic currency.
79
Does PPP hold in the real world?

No, for two reasons:
1. International arbitrage not possible.
 nontraded goods (非貿易財)
 transportation costs
2. Different countries’ goods not perfect substitutes.

Nonetheless, PPP is a useful theory:
 It’s simple & intuitive
 In the real world, nominal exchange rates
tend toward their PPP values over the long run.
80
Fig 5-14: NX is highly sensitive to small movements in
εunder PPP  very flat NX schedule
If ε = 1
→
the NX curve is horizontal
:
ε
ε =1
S I
NX
Under PPP,
changes in (S – I )
have no impact on
ε or e.
NX
81
Alternative :
Interest rate parity 利率平價理論
補充PPP
 連結利率、當期匯率、與遠期匯率。

82
Summary
Y  C  I  G  NX
S  Y  C  G  I  NX
S  I  NCO
NX  NCO
nominal exchange rate (e)
QF
P
real exchange rate 

Q
ePF
PPP theory: LR equilibrium
QF
P
real exchange rate 

1
Q
e * PF
or e* 
P
PF
83
Summary
Open Macro Model: two markets are central
(1) LF Market: S = I + NCO
(2) FE Market: NCO = NX
1. Large Open Economy:
 NCO links the LF market and FE market.
 r and εadjust simultaneously to achieve equilibrium
2. Small Open Economy: r=r*, NCO=S-I(r*) + NX ε*

Comparative Statics
84