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

Chapter
17
Macroeconomics
in an Open Economy
Prepared by:
Fernando & Yvonn Quijano
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
NewPage Paper
versus China
Learning Objectives
17.1 Explain how the balance of
payments is calculated.
17.2 Explain how exchange rates are
determined and how changes in
exchange rates affect the prices
of imports and exports.
17.3 Explain the saving and investment
equation.
17.4 Explain the effect of a government
budget deficit on investment in an
open economy.
Under existing international trade
agreements, governments are not
allowed to subsidize firms that
export to other countries…
17.5 Discuss the difference between the
effectiveness of monetary and fiscal
policy in an open economy and in a
closed economy.
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Learning Objective 17.1
Chapter 17: Macroeconomics in an Open Economy
The Balance of Payments: Linking the
United States to the International Economy
Open economy An economy that
has interactions in trade or finance
with other countries.
Closed economy An economy that
has no interactions in trade or finance
with other countries.
Balance of payments The record of
a country’s trade with other countries
in goods, services, and assets.
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Learning Objective 17.1
The Balance of Payments: Linking the
United States to the International Economy
Chapter 17: Macroeconomics in an Open Economy
The Current Account
Current account The part of the
balance of payments that records a
country’s net exports, net investment
income, and net transfers.
The Balance of Trade
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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Learning Objective 17.1
The Balance of Payments: Linking the
United States to the International Economy
The Current Account
Chapter 17: Macroeconomics in an Open Economy
FIGURE 17.1
Trade Flows for the United
States and Japan, 2006
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Learning Objective 17.1
The Balance of Payments: Linking the
United States to the International Economy
Chapter 17: Macroeconomics in an Open Economy
The Current Account
Net Exports Equals the Sum of the Balance of Trade
and the Balance of Services
Table 17-1
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
80
Income received on investments
650
Income payments on investments
−614
Net income on investments
−36
Net transfers
−90
Balance on current account
−812
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Learning Objective 17.1
The Balance of Payments: Linking the
United States to the International Economy
Chapter 17: Macroeconomics in an Open Economy
The Current Account
Net Exports Equals the Sum of the Balance of Trade
and the Balance of Services
Table 17-1
The Balance of Payments of
the United States, 2006
(billions of dollars) (continued)
FINANCIAL ACCOUNT
Increase in foreign holdings of assets in the United States
Increase in U.S. holdings of assets in foreign countries
1,860
−1,055
Balance on Financial Account
805
BALANCE ON CAPITAL ACCOUNT
-4
Statistical discrepancy
11
Balance of payments
0
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Learning Objective 17.1
The Balance of Payments: Linking the
United States to the International Economy
Chapter 17: Macroeconomics in an Open Economy
The Financial Account
Financial account The part of the
balance of payments that records
purchases of assets a country has made
abroad and foreign purchases of assets
in the country.
Net foreign investment The difference
between capital outflows from a country
and capital inflows, also equal to net
foreign direct investment plus net
foreign portfolio investment.
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Learning Objective 17.1
The Balance of Payments: Linking the
United States to the International Economy
Chapter 17: Macroeconomics in an Open Economy
The Capital Account
Capital account The part of the balance
of payments that records relatively minor
transactions, such as migrants’ transfers,
and sales and purchases of nonproduced,
nonfinancial assets.
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Learning Objective 17.1
The Balance of Payments: Linking the
United States to the International Economy
Chapter 17: Macroeconomics in an Open Economy
Why Is the Balance of Payments Always Zero?
The sum of the current account balance, the financial
account balance, and the capital account balance
equals the balance of payments.
To make the balance on the current account equal the
balance on the financial account, the balance of
payments includes an entry called the statistical
discrepancy.
Don’t Let This Happen to YOU!
Don’t Confuse the Balance of Trade, the Current
Account Balance, and the Balance of Payments
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Learning Objective 17.1
Solved Problem
17-1
Chapter 17: Macroeconomics in an Open Economy
Understanding the Arithmetic of Open Economies
Test your understanding of the relationship between the current
account and the financial account by evaluating the following
assertion by a political commentator:
“The industrial countries are committing economic suicide.
Every year, they invest more and more in developing countries.
Every year, more U.S., Japanese, and European
manufacturing firms move their factories to developing
countries. With extensive new factories and low wages,
developing countries now export far more to the industrial
countries than they import.”
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Learning Objective 17.2
Chapter 17: Macroeconomics in an Open Economy
The Foreign Exchange Market and Exchange Rates
Nominal exchange rate
The value of one country’s
currency in terms of another
country’s currency.
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Learning Objective 17.2
Making
the
Chapter 17: Macroeconomics in an Open Economy
Connection
Exchange Rates in the
Financial Pages
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
The financial pages
of most newspapers
provide information
on exchange rates.
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Learning Objective 17.2
Chapter 17: Macroeconomics in an Open Economy
The Foreign Exchange Market and Exchange Rates
There are three sources of foreign currency 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 Currency traders who believe that the value of the
dollar in the future will be greater than its value today.
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Learning Objective 17.2
The Foreign Exchange Market and Exchange Rates
Chapter 17: Macroeconomics in an Open Economy
Equilibrium in the Market for Foreign Exchange
FIGURE 17.2
Equilibrium in the
Foreign Exchange
Market
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Learning Objective 17.2
The Foreign Exchange Market and Exchange Rates
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.
Don’t Let This Happen to YOU!
Remember That Modern Currencies Are Fiat Money
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Learning Objective 17.2
The Foreign Exchange Market and Exchange Rates
Chapter 17: Macroeconomics in an Open Economy
How Do Shifts in Demand and Supply Affect
the Exchange Rate?
Three main factors 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 foreign-produced 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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Learning Objective 17.2
The Foreign Exchange Market and Exchange Rates
Chapter 17: Macroeconomics in an Open Economy
How Do Shifts in Demand and Supply Affect
the Exchange Rate?
Shifts in the Demand for Foreign Exchange
Speculators Currency traders who buy
and sell foreign exchange in an attempt to
profit from changes in exchange rates.
Shifts in the Supply of Foreign Exchange
The factors that affect the supply curve for dollars
are similar to those that affect the demand curve
for dollars.
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Learning Objective 17.2
The Foreign Exchange Market and Exchange Rates
Chapter 17: Macroeconomics in an Open Economy
How Do Shifts in Demand and Supply Affect
the Exchange Rate?
Adjustment to a New Equilibrium
FIGURE 17.3
Shifts in the Demand
and Supply Curve
Resulting in a Higher
Exchange Rate
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Learning Objective 17.2
The Foreign Exchange Market and Exchange Rates
Chapter 17: Macroeconomics in an Open Economy
Some Exchange Rates Are Not Determined by the Market
Some currencies have fixed exchange
rates that do not change over long periods.
How Movements in the Exchange Rate Affect
Exports and Imports
If the economy is currently below potential GDP, then,
holding all other factors constant, a depreciation in the
domestic currency should increase net exports, aggregate
demand, and real GDP.
An appreciation in 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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Learning Objective 17.2
Solved Problem
17-2
Chapter 17: Macroeconomics in an Open Economy
The Effect of Changing Exchange Rates
on the Prices of Imports and Exports
In March 2001, the average price of goods imported
into the United States from Canada fell 3.3 percent.
This decline was the largest since the federal
government began gathering such statistics in 1992.
Is it likely that the value of the U.S. dollar appreciated
or depreciated versus the Canadian dollar during this
period? Is it likely that the average price in Canadian
dollars of goods exported from the United States to
Canada during March 2001 rose or fell?
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Learning Objective 17.2
The Foreign Exchange Market and Exchange Rates
Chapter 17: Macroeconomics in an Open Economy
The Real Exchange Rate
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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Learning Objective 17.3
The International Sector and National
Saving and Investment
FIGURE 17.4
Chapter 17: Macroeconomics in an Open Economy
U.S. Imports and Exports,
1970–2006
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Learning Objective 17.3
The International Sector and National
Saving and Investment
Chapter 17: Macroeconomics in an Open Economy
Net Exports Equal Net Foreign Investment
Current Account Balance + Financial Account Balance = 0
or:
Current Account Balance = -Financial Account Balance
or:
Net Exports = Net Foreign Investment
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Learning Objective 17.3
The International Sector and National
Saving and Investment
Chapter 17: Macroeconomics in an Open Economy
Domestic Saving, Domestic Investment,
and Net Foreign Investment
National Saving = Private Saving + Public Saving
S = Sprivate + Spublic
Private Saving = National Income – Consumption - Taxes
Sprivate = Y – C – T
Government Saving = Taxes – Government Spending
Spublic = T – G
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Learning Objective 17.3
The International Sector and National
Saving and Investment
Chapter 17: Macroeconomics in an Open Economy
Domestic Saving, Domestic Investment,
and Net Foreign Investment
Remember the basic macroeconomic equation for
GDP or national income:
Y = C + I + G + NX
Saving and investment equation An equation
that shows that national saving is equal to
domestic investment plus net foreign investment.
National Saving = Domestic Investment + Net Foreign Investment
S = I + NFI
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Learning Objective 17.3
Solved Problem
17-3
Chapter 17: Macroeconomics in an Open Economy
Arriving at the Saving and Investment Equation
S = Sprivate + Spublic = (Y − C − T) + (T − G) = Y − C − G
S = (C + I + G + NX) − C − G
S = I + NX
S = I + NFI
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Learning Objective 17.4
The Effect of a Government Budget Deficit
on Investment
FIGURE 17.5
Chapter 17: Macroeconomics in an Open Economy
The Twin Deficits, 1978–2006
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Learning Objective 17.4
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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Learning Objective 17.5
Monetary Policy and Fiscal Policy
in an Open Economy
Chapter 17: Macroeconomics in an Open Economy
Monetary Policy in an Open Economy
When the Federal Reserve engages in
an expansionary monetary policy, it buys
Treasury securities to lower interest rates
and stimulate aggregate demand.
Fiscal Policy in an Open Economy
To engage in an expansionary fiscal
policy, the federal government increases
its purchases or cuts taxes. Increases in
government purchases directly increase
aggregate demand.
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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
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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