Transcript Mankiw 5/e Chapter 5: The Open Economy

Imports and Exports
as a percentage of output: 2000
Percentage40
of GDP
35
30
25
20
15
10
5
0
Canada France Germany
Imports
Exports
Italy
Japan
U.K.
U.S.
slide 0
Three experiments
1. Fiscal policy at home
2. Fiscal policy abroad
3. An increase in investment demand
slide 1
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
S, I
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NX and the Government Budget Deficit
4
Percent
of GDP 3
8 Percent
of GDP
6
Budget deficit
(right scale)
2
4
1
2
0
0
-1
-2
-2
-4
Net exports
(left scale)
-3
-4
1950
-6
-8
1960
1970
1980
1990
2000
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2. Fiscal policy abroad
Expansionary
fiscal policy
abroad raises
the world
interest rate.
r
NX2
r2*
S1
NX1
r
*
1
Results:
I  0
I (r )
NX  I  0
I (r )
*
2
I (r1* )
S, I
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3. An increase in investment demand
r
S
r*
EXERCISE:
Use the model to
determine the impact
of an increase in
investment demand
on NX, S, I, and net
capital outflow.
NX1
I (r )1
I1
S, I
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3. An increase in investment demand
r
ANSWERS:
I > 0,
S = 0,
S
NX2
r*
net capital
outflows and
net exports
fall by the
amount I
NX1
I (r )2
I (r )1
I1
I2
S, I
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2
140
1
120
0
100
-1
80
-2
60
-3
40
-4
20
-5
0
1975
1980
1985
1990
1995
1998:2 = 100
Percent of GDP
U.S. Net Exports and the
Real Exchange Rate, 1975-2002
2000
Net exports (left scale)
Real exchange rate (right scale)
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Four experiments
1. Fiscal policy at home
2. Fiscal policy abroad
3. An increase in investment demand
4. Trade policy to restrict imports
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1. Fiscal policy at home
A fiscal expansion
reduces national
saving, net capital
outflows, and the
supply of dollars in
the foreign
exchange market…
…causing the
real exchange
rate to rise and
NX to fall.
ε
S 2  I (r *)
S 1  I (r *)
ε2
ε1
NX(ε )
NX 2
NX 1
NX
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2. Fiscal policy abroad
An increase in r*
reduces investment, ε
increasing net
capital outflows and ε
1
the supply of dollars
in the foreign
exchange market… ε 2
…causing the
real exchange
rate to fall and
NX to rise.
S 1  I (r1 *)
S 1  I (r2 *)
NX(ε )
NX 1
NX 2
NX
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3. An increase in investment demand
An increase in
investment
reduces net
capital outflows
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
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4. Trade policy to restrict imports
At any given value of
ε
ε, an import quota
 IM  NX
 demand for
ε2
dollars shifts
right
ε1
Trade policy doesn’t
affect S or I , so
capital flows and the
supply of dollars
remains fixed.
S I
NX (ε )2
NX (ε )1
NX1
NX
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4. Trade policy to restrict imports
Results:
ε > 0
(demand
increase)
NX = 0
(supply fixed)
IM < 0
(policy)
EX < 0
(rise in ε )
ε
S I
ε2
ε1
NX (ε )2
NX (ε )1
NX1
NX
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Inflation and nominal exchange rates
Percentage 10
change
9
in nominal
exchange 8
rate
7
6
5
4
3
2
1
0
-1
-2
-3
-4
South Africa
Depreciation
relative to
U.S. dollar
Italy
New Zealand
Australia
Spain
Sweden
Ireland
Canada
Belgium
Germany
UK
France
Appreciation
relative to
U.S. dollar
Netherlands
Switzerland
Japan
-3
-2
-1
0
1
2
3
4
5
6
7
8
Inflation differential
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CASE STUDY
The Reagan Deficits revisited
actual
1970s 1980s
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.
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