Transcript Mankiw 6e PowerPoints

6
The Open Economy
MACROECONOMICS
N. Gregory Mankiw
PowerPoint ® Slides by Ron Cronovich
© 2013 Worth Publishers, all rights reserved
IN THIS CHAPTER, YOU WILL LEARN:
 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
1
Imports and exports of selected countries, 2010
60
Exports
Percent of GDP
50
Imports
40
30
20
10
0
Australia
China
Germany
Greece
S. Korea
Mexico
United
States
Imports and exports of Korea, 1997 - 2012
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The Open Economy
3
3
In an open economy,
 spending need not equal output
 saving need not equal investment
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4
Preliminaries
C C d C f
I Id If
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 (a.k.a. the “trade balance”)
= EX – IM
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The Open Economy
5
GDP = expenditure on
domestically produced g & s
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
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6
The national income identity
in an open economy
Y = C + I + G + NX
or,
NX = Y – (C + I + G )
domestic
spending
net exports
output
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7
Trade surpluses and deficits
NX = EX – IM = Y – (C + I + G )
 trade surplus:
output > spending and exports > imports
Size of the trade surplus = NX
 trade deficit:
spending > output and imports > exports
Size of the trade deficit = –NX
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8
International capital flows
 Net capital outflow
=S –I
= net outflow of “loanable funds”
= net purchases of foreign assets
the country’s purchases of foreign assets
minus foreign purchases of domestic assets
 When S > I, country is a net lender
 When S < I, country is a net borrower
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9
The link between trade & cap. flows
NX = Y – (C + I + G )
implies
NX = (Y – C – G ) – I
=
S
–
I
trade balance = net capital outflow
Thus,
a country with a trade deficit (NX < 0)
is a net borrower (S < I ).
CHAPTER 6
The Open Economy
10
Saving, investment, and the trade balance
1960–2012
25%
15%
20%
10%
15%
5%
saving
10%
0%
5%
-5%
trade balance
(right scale)
0%
-10%
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Trade Balance (% of GDP)
Saving, Investment (% of GDP)
investment
U.S.: The world’s largest debtor nation
 Every year since 1980s: huge trade deficits and
net capital inflows, i.e. net borrowing from abroad
 As of 12/31/2011:
 U.S. residents owned $21.1 trillion worth of
foreign assets
 Foreigners owned $25.1 trillion worth of
U.S. assets
 U.S. net indebtedness to rest of the world:
$4.0 trillion—higher than any other country,
hence U.S. is the “world’s largest debtor nation”
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12
Since the late 1990s, the US current account deficits grew until 2006 when it
reached over 1.5% of world GDP.
China’s current account surplus increased remarkably fast until 2008.
Japan’s surplus also continues to be large and the current account surplus of
other East Asian countries are not negligible.
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13
<Figure 3> Trend of Net Portfolio Investment Positions of East Asian Countries in the U.S.
(US$ Million)
 China has increased its portfolio investment very rapidly.
 East Asian countries’ investment in the US continued to grow.
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14
 Global imbalances of the last decade have been accompanied by massive
capital flows from East Asian countries to the US.
Even after the global crisis, East Asian countries’ investment in the US
continued to grow.
 China is the biggest investor in the US, followed by Japan.
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15
Saving and investment in a
small open economy
 An open-economy version of the loanable
funds model from Chapter 3.
 Includes many of the same elements:
 production function
 consumption function
 investment function
Y Y  F (K , L)
C  C (Y T )
I  I (r )
 exogenous policy variables G  G , T  T
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16
National saving:
The supply of loanable funds
r
S Y  C (Y T )  G
As in Chapter 3,
national saving does
not depend on the
interest rate
S
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The Open Economy
S, I
17
Assumptions about capital flows
a. domestic & foreign bonds are perfect substitutes
(same risk, maturity, etc.)
b. perfect capital mobility:
no restrictions on international trade in assets
c. economy is small:
cannot affect the world interest rate, denoted r*
a & b imply r = r*
c implies r* is exogenous
CHAPTER 6
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18
Investment:
The demand for loanable funds
r
r*
Investment is still a
downward-sloping function
of the interest rate,
but the exogenous
world interest rate…
…determines the
country’s level of
investment.
I (r )
I (r* )
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The Open Economy
S, I
19
If the economy were closed…
r
…the interest
rate would
adjust to
equate
investment
and saving:
S
rc
I (r )
I (rc )
S
CHAPTER 6
The Open Economy
S, I
20
But in a small open economy…
the exogenous
world interest
rate determines
investment…
…and the
difference
between saving
and investment
determines net
capital outflow
and net exports
CHAPTER 6
r
S
NX
r*
rc
The Open Economy
I (r )
I1
S, I
21
Next, three experiments:
1. Fiscal policy at home
2. Fiscal policy abroad
3. An increase in investment demand
(exercise)
CHAPTER 6
The Open Economy
22
1.
Fiscal policy at home
r
An increase in G
or decrease in T
reduces saving.
r
*
1
S 2 S1
NX2
NX1
Results:
I  0
I (r )
NX  S  0
I1
CHAPTER 6
The Open Economy
S, I
23
NX and the federal budget deficit
(% of GDP), 1965–2012
10%
2%
Budget deficit
(left scale)
8%
0%
6%
4%
-2%
2%
0%
-2%
Net exports
(right scale)
-4%
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
-4%
-6%
2.
Fiscal policy abroad
Expansionary
fiscal policy
abroad raises
the world
interest rate.
r
NX2
r2*
NX1
r
*
1
Results:
I (r )
I  0
NX  I  0
I (r )
*
2
CHAPTER 6
S1
The Open Economy
I (r1* )
S, I
25
NOW YOU TRY
3.
An increase in investment demand
Use the
model to
determine
the impact of
an increase
in investment
demand on
NX, S, I, and
net capital
outflow.
r
r
S
*
NX1
I (r )1
I1
S, I
26
ANSWERS
3.
An increase in investment demand
r
I > 0,
S = 0,
net capital
outflow and
NX fall
by the
amount I
r
S
NX2
*
NX1
I (r )2
I (r )1
I1
I2
S, I
27
The nominal exchange rate
e = nominal exchange rate,
the relative price of
domestic currency
in terms of foreign currency
(e.g. yen per dollar)
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28
A few exchange rates, as of 5/24/2012
country
exchange rate
Euro area
0.79 euro/$
Indonesia
9,437 rupiahs/$
Japan
79.6 yen/$
Mexico
14.0 pesos/$
Russia
31.79 rubles/$
South Africa
8.35 rand/$
U.K.
0.63 pounds/$
Won/US Dollar Exchange Rate
CHAPTER 6
The Open Economy
Source: Bank of Korea 30
30
The real exchange rate
ε = real exchange rate,
the lowercase
Greek letter
epsilon
CHAPTER 6
the relative price of
domestic goods
in terms of foreign goods
(e.g. Japanese Big Macs per
U.S. Big Mac)
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31
Understanding the units of ε
ε 
e P
P *
(Yen per $)  ($ per unit U.S. goods)

Yen per unit Japanese goods
CHAPTER 6

Yen per unit U.S. goods
Yen per unit Japanese goods

Units of Japanese goods
per unit of U.S. goods
The Open Economy
32
~ McZample ~
 one good: Big Mac
 price in Japan:


P* = 200 Yen
price in USA:
P = $2.50
nominal exchange rate
e = 120 Yen/$
ε
e P

P*
120  $2.50

 1 .5
200 Yen
CHAPTER 6
The Open Economy
To buy a U.S. Big Mac,
someone from Japan
would have to pay an
amount that could buy
1.5 Japanese Big Macs.
33
ε in the real world & our model
 In the real world:
We can think of ε as the relative price of
a basket of domestic goods in terms of a basket
of foreign goods
 In our macro model:
There’s just one good, “output.”
So ε is the relative price of one country’s output
in terms of the other country’s output
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How NX depends on ε
ε  U.S. goods become more expensive
relative to foreign goods
 EX, IM
 NX
CHAPTER 6
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35
U.S. net exports and the real exchange rate,
1973–2012
4%
140
Trade-weighted real
exchange rate index
120
100
0%
80
-2%
60
-4%
40
Net exports
(left scale)
-6%
-8%
1970
20
0
1975
1980
1985
1990
1995
2000
2005
2010
Index (March 1973 = 100)
NX (% of GDP)
2%
The net exports function
 The net exports function reflects this inverse
relationship between NX and ε :
NX = NX(ε )
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The NX curve for the U.S.
ε
When ε is
relatively low,
U.S. goods are
relatively
inexpensive
so U.S. net
exports will
be high
ε1
NX (ε)
0
CHAPTER 6
The Open Economy
NX(ε1)
NX
38
The NX curve for the U.S.
ε
ε2
At high enough
values of ε,
U.S. goods become
so expensive that
we export
less than
we import
NX (ε)
NX(ε2)
CHAPTER 6
0
The Open Economy
NX
39
How ε is determined
 The accounting identity says NX = S – I
 We saw earlier how S – I is determined:
 S depends on domestic factors (output, fiscal
policy variables, etc.)
 I is determined by the world interest
rate r *
 So, ε must adjust to ensure
NX (ε )  S  I (r *)
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40
How ε is determined
Neither S nor I
depends on ε,
so the net capital
outflow curve is
vertical.
ε adjusts to
ε
ε1
equate NX
with net capital
outflow, S  I.
CHAPTER 6
S 1  I (r *)
The Open Economy
NX(ε )
NX 1
NX
41
Interpretation: supply and demand
in the foreign exchange market
demand:
Foreigners need
dollars to buy
U.S. net exports.
ε
supply:
Net capital
outflow (S  I )
is the supply of
dollars to be
invested abroad.
ε1
CHAPTER 6
The Open Economy
S 1  I (r *)
NX(ε )
NX 1
NX
42
Next, four experiments:
1. Fiscal policy at home
2. Fiscal policy abroad
3. An increase in investment demand
(exercise)
4. Trade policy to restrict imports
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43
1. Fiscal policy at home
A fiscal expansion
reduces national
saving, net capital
outflow, and the
supply of dollars
in the foreign
exchange
market…
ε
S 1  I (r *)
ε2
ε1
…causing the real
exchange rate to
rise and NX to fall.
CHAPTER 6
S 2  I (r *)
The Open Economy
NX(ε )
NX 2
NX 1
NX
44
2. Fiscal policy abroad
An increase in r*
reduces
investment,
increasing net
capital outflow
and the supply of
dollars in the
foreign exchange
market…
…causing the real
exchange rate to fall
and NX to rise.
CHAPTER 6
ε
S 1  I (r1 *)
S 1  I (r2 *)
ε1
ε2
The Open Economy
NX(ε )
NX 1
NX 2
NX
45
NOW YOU TRY
3.
Increase in investment demand
Determine the
impact of an
increase in
investment
demand on
net exports,
net capital
outflow,
and the real
exchange rate.
ε
S1  I 1
ε1
NX(ε )
NX 1
NX
46
ANSWERS
3.
Increase in investment demand
An increase in
investment
reduces net
capital outflow
and the supply
of dollars in the
foreign
exchange
market…
…causing the real
exchange rate to
rise and NX to fall.
ε
S1  I 2
S1  I 1
ε2
ε1
NX(ε )
NX 2
NX 1
NX
47
4. Trade policy to restrict imports
At any given value of
ε, an import quota
ε
 IM  NX
 demand for
ε2
dollars shifts
right
S I
ε1
Trade policy doesn’t
affect S or I , so
capital flows and the
supply of dollars
remain fixed.
CHAPTER 6
The Open Economy
NX (ε )2
NX (ε )1
NX1
NX
48
4. Trade policy to restrict imports
Results:
ε > 0
(demand
increase)
NX = 0
(supply fixed)
IM < 0
(policy)
EX < 0
(rise in ε )
CHAPTER 6
ε
S I
ε2
ε1
The Open Economy
NX (ε )2
NX (ε )1
NX1
NX
49
CHAPTER SUMMARY
 Net exports—the difference between
 exports and imports
 a country’s output (Y )
and its spending (C + I + G)
 Net capital outflow equals
 purchases of foreign assets
minus foreign purchases of the country’s assets
 the difference between saving and investment
50
CHAPTER SUMMARY
 National income accounts identities
 Y = C + I + G + NX
 trade balance NX = S – I net capital outflow
 Impact of policies on NX
 NX increases if policy causes S to rise
or I to fall
 NX does not change if policy affects
neither S nor I. Example: trade policy
51
CHAPTER SUMMARY
 Exchange rates
 nominal: the price of a country’s currency in
terms of another country’s currency
 real: the price of a country’s goods in terms of
another country’s goods
 The real exchange rate equals the nominal rate
times the ratio of prices of the two countries.
52
CHAPTER SUMMARY
 How the real exchange rate is determined
 NX depends negatively on the real exchange
rate, other things equal
 The real exchange rate adjusts to equate
NX with net capital outflow
53