LECTURE6 - SESS1004 Introduction to Macroeconomics Lecture...

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SESS1004 Introduction to Macroeconomics Lecture 6 The IS-LM Model in an Open Economy Dragos Radu [email protected]
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polls during lecture 6 log in to slido.com with the code for lecture 6: macro6
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net capital imports / exports
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general macroeconomic equilibrium goods market money market foreign exchange market real exchange rates affect aggregate demand income influences demand for money interest rates affect aggregate demand interest rates influence the exchange rate
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outline lecture 5 open goods markets open financial markets balance of payments IS-LM in an open economy
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the open economy we drop the assumption of a closed economy three dimensions: trade openness (goods markets): subject to free trade restrictions (tariffs and quotas) financial markets : subject to capital controls (restrictions on the ownership of foreign assets) factor flows (migration, foreign direct investment)
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export ratio both the export ratio and the intensity of trade depend on: geography / distance size: the smaller the country, the more it must specialise in production/export and rely on imports for other products
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goods market when goods markets are open: demand central to the second decision is the price of domestic goods relative to foreign goods: the real exchange rate consume save domestic goods foreign goods
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nominal exchange rate an exchange rate (E) is the price of some foreign currency expressed in terms of a home (or domestic) currency because an exchange rate is the relative price of two currencies, it may be quoted in either of two ways: 1. The number of foreign currency units that can be exchanged for one unit of home currency. 2. The number of home currency units that can be exchanged for one unit of foreign currency.
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nominal exchange rate the format in which exchange rates are quoted is essential to avoid confusion, even if it is arbitrary we will use the first definition here: the price of the domestic currency (£) in terms of the foreign currency (Euro)…. e.g. £/€ €/£ 1 E = E €/£ E = 1.15
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exchange rate regimes Fixed (or pegged) exchange rate regimes: E fluctuates in a narrow range (or not at all) against some base currency over a sustained period, usually a year or longer. ( A country’s exchange rate can remain rigidly fixed for long periods only if the government intervenes in the foreign exchange market in one or both countries. ) Floating (or flexible) exchange rate regimes E fluctuates in a wider range, and the government makes no attempt to fix it against any base currency. Appreciations and depreciations may occur from year to year, each month, by the day, or every minute.
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