Transcript Economics R. Glenn Hubbard, Anthony Patrick O`Brien, 2e.

Chapter 17: Macroeconomics in an Open Economy
The Balance of Payments: Linking the
United States to the International Economy
Balance of payments The record of
a country’s trade with other countries
in goods, services, and assets.
Current account The part of the
balance of payments that records a
country’s net exports, net investment
income, and net transfers.
Balance of trade The difference
between the value of the goods a
country exports and the value of the
goods a country imports.
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Chapter 17: Macroeconomics in an Open Economy
Trade Flows for the United
States, 2006
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Chapter 17: Macroeconomics in an Open Economy
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Net Exports Equals the Sum of the Balance of Trade
and the Balance of Services
Chapter 17: Macroeconomics in an Open Economy
CURRENT ACCOUNT
The Balance of
Payments of the
United States, 2006
(billions of dollars)
Exports of goods
$1,023
Imports of goods
−1,861
−838
Balance of trade
Exports of services
423
Imports of services
−343
Balance of services
Income received on investments
Income payments on investments
80
650
−614
Net income on investments
−36
Net transfers
−90
Balance on current account
−812
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Chapter 17: Macroeconomics in an Open Economy
U.S. Imports and Exports,
1970–2006
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So how do we pay for the excess of current account payments
Don’t Let This
to foreigners over what they pay to US?
Happen to YOU!
FINANCIAL ACCOUNT
Increase in foreign holdings of assets in the United
States
Chapter 17: Macroeconomics in an Open Economy
Increase in U.S. holdings of assets in foreign countries
Balance on Financial Account
1,860
−1,055
Don’t Confuse the
Balance of Trade, the
Current Account
Balance, and the
Balance of Payments
805
BALANCE ON CAPITAL ACCOUNT
-4
Statistical discrepancy
11
Balance of payments
0
We sell them our IOUs and other assets (stocks, real estate deeds,
condos…)
Net foreign investment The difference between capital outflows from
a country and capital inflows, also equal to net foreign direct investment
(in “factories”) plus net foreign portfolio investment (stocks and bonds).
The Balance of Payments Is Always Zero (statistical discrepancy
makes it so)
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Exchange Rates in the
Financial Pages
Chapter 17: Macroeconomics in an Open Economy
EXCHANGE RATE BETWEEN THE DOLLAR AND THE
INDICATED CURRENCY
UNITS OF FOREIGN
CURRENCY
PER U.S. DOLLAR
U.S. DOLLAR PER UNIT
OF FOREIGN CURRENCY
1.067
0.937
Japanese yen
122.650
0.008
Mexican peso
10.919
0.092
British pound
0.507
1.972
Euro
0.752
1.330
CURRENCY
Canadian dollar
That was then…this is now
http://www.bloomberg.com/markets/currencies/fxc.html
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The Foreign Exchange Market and Exchange Rates
Chapter 17: Macroeconomics in an Open Economy
Sources of demand for the U.S. dollar:
1 Foreign firms and households who want to buy goods and services
produced in the United States.
2 Foreign firms and households who want to invest
in the United States either through foreign direct investment —
buying or building factories or other facilities in the United States
— or through foreign portfolio investment — buying stocks and
bonds issued in the United States.
3 People doing international business transacted in dollars.
3 Currency traders who believe the value of the dollar will increase.
Sources of supply of the U.S. dollar are analogous: US residents
who want to buy foreign stuff or paper or hold foreign currencies
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Chapter 17: Macroeconomics in an Open Economy
Equilibrium in the Market for Foreign Exchange
Currency
appreciation An
increase in the
market value of one
currency relative to
another currency.
Currency
depreciation A
decrease in the
market value of one
currency relative to
another currency.
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Chapter 17: Macroeconomics in an Open Economy
How Do Shifts in Demand and Supply Affect
the Exchange Rate?
Factors that cause the demand and supply curves in the
foreign exchange market to shift:
1 Changes in the demand for U.S.-produced goods and
services and changes in the demand for foreignproduced goods and services
2 Changes in the desire to invest in the United States and
changes in the desire to invest in foreign countries
3 Changes in the expectations of currency traders about
the likely future value of the dollar and the likely future
value of foreign currencies
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How Do Shifts in Demand and Supply Affect
the Exchange Rate?
Chapter 17: Macroeconomics in an Open Economy
Adjustment to a New Equilibrium
Shifts in the Demand
and Supply Curve
Resulting in a Higher
Exchange Rate
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The Foreign Exchange Market and Exchange Rates
Some Exchange Rates Are Not Determined by the Market
Some currencies have fixed exchange rates that do not change … until they
Chapter 17: Macroeconomics in an Open Economy
are forced to: payments deficit drains Central Bank foreign exchange
holdings; Ms declines; i rises  capital inflows; Y and P fall  Im decline
 Balance of Payments balances at the fixed exchange rate.
How Movements in the Exchange Rate Affect Exports and Imports
If the economy is currently below potential GDP, then
depreciation/devaluation of the domestic currency should increase net
exports, aggregate demand, and real GDP.
Appreciation/revaluation of the domestic currency should have the
opposite effect: Exports should fall, and imports should rise, which will
reduce net exports, aggregate demand, and real GDP.
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Chapter 17: Macroeconomics in an Open Economy
Real exchange rate The price of domestic goods in terms of
foreign goods.
 Domestic price level 
Real exchange rate = Nominal exchange rate × 

 Foreign price level 
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The International Sector and National
Saving and Investment
Chapter 17: Macroeconomics in an Open Economy
U.S. Imports and Exports,
1970–2006
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Chapter 17: Macroeconomics in an Open Economy
Current Account Balance + Financial Account Balance = 0
or:
Current Account Balance = -Financial Account Balance
or:
Net Exports = Net Foreign Investment … NX = NFI
Private Saving = National Income – Consumption - Taxes
Sprivate = Y – C – T = (C + I + G + NX) - C - T = I + (G - T) + NX
Private saving finances domestic and foreign investment and
government deficit
Public Saving = Taxes – Gov’t Spending = Spublic = T – G
National Saving = Private Saving + Public Saving
S = Sprivate + Spublic
S = [I + (G - T) + NX] + (T - G) = I + NFI
- NFI = I - S = I - Sprivate - (T - G) = (I - Sprivate) + (G - T)
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The Effect of a Government Budget Deficit
on Investment
Chapter 17: Macroeconomics in an Open Economy
The Twin Deficits, 1978–2006
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Making
the
Chapter 17: Macroeconomics in an Open Economy
Connection
Why Is the United States Called
the “World’s Largest Debtor”?
Large current account
deficits have resulted in
foreign investors purchasing
large amounts of U.S. assets.
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An Inside LOOK
Can the U.S. Current Account
Deficit Be Sustained?
Chapter 17: Macroeconomics in an Open Economy
Sustaining the Unsustainable
U.S. trade-weighted exchange index: Major currencies.
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Chapter 17: Macroeconomics in an Open Economy
Macro Pictures: Exchange Rate
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Chapter 17: Macroeconomics in an Open Economy
Key Terms
Balance of payments
Net foreign investment
Balance of trade
Nominal exchange rate
Capital account
Open economy
Closed economy
Real exchange rate
Currency appreciation
Saving and investment equation
Currency depreciation
Speculators
Current account
Financial account
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