Lecture%2021 - Economics 102 Lecture 21: Open Economy Macro...

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1 Economics 102 Lecture 21 : Open Economy Macro II LECTURE 21 OPEN ECONOMY MACRO II 1 Open Economy Macro II § The yen (¥), the euro (€), and the dollar ($) are the world’s three big currencies. The dollar and the yen have been around for a long time. The euro was created in the 1990s. In August 2002, 1 dollar bought 1.02 euros. In November 2007, 1 dollar bought only 0.68 euros. Why do currency exchange rates fluctuate? LECTURE 21 OPEN ECONOMY MACRO II 2 In the News § Markets Tumble As Dollar's Fall Adds to Anxiety By JOANNA SLATER and CRAIG KARMIN Wall Street Journal , November 8, 2007 ; Page A1 The credit crisis sparked by mortgage problems reared its head anew, as stocks tumbled on fears about shaky financial institutions. This time, the dollar's fall to record lows and oil's flirtation with $100 a barrel added to the worrisome brew. The Dow Jones Industrial Average fell 360.92 points, or 2.64%, to 13300.02. The index has now wiped out all of its gains since the Federal Reserve on Sept. 18 made the first of its two recent interest-rate cuts, sparking a short-lived rally that sent the Dow to a record high Oct. 9.
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2 LECTURE 21 OPEN ECONOMY MACRO II 3 In this lecture, look for the answers to these questions: § In an open economy, what determines the real interest rate? The real exchange rate? § How are the markets for loanable funds and foreign-currency exchange connected? § How do government budget deficits affect the exchange rate and trade balance? § How do other policies or events affect the interest rate, exchange rate, and trade balance? LECTURE 21 OPEN ECONOMY MACRO II 4 Introduction § The previous chapter explained the basic concepts and vocabulary of the open economy: net exports ( NX ), net capital outflow ( NCO ), and exchange rates. § This chapter ties these concepts together into a theory of the open economy in the long run. § We will use this theory to see how government policies and various events affect the trade balance, exchange rate, and capital flows. § We start with the loanable funds market… LECTURE 21 OPEN ECONOMY MACRO II 5 The Market for Loanable Funds § An identity from the preceding chapter: § Supply of loanable funds = . § A dollar of saving can be used to finance the purchase of the purchase of § So, demand for loanable funds =
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3 LECTURE 21 OPEN ECONOMY MACRO II 6 The Market for Loanable Funds § Recall: S depends positively on the real interest rate, r . I depends negatively on r . § What about NCO ? LECTURE 21 OPEN ECONOMY MACRO II 7 How NCO Depends on the Real Interest Rate The real interest rate, r , is the real return on domestic assets. A fall in r makes domestic assets less attractive relative to . People in the U.S. purchase People abroad purchase NCO rises. r NCO NCO r 2 Net capital outflow r 1 NCO 1 NCO 2 LECTURE 21 OPEN ECONOMY MACRO II 8 D = I + NCO r adjusts to balance supply and demand in the LF market.
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Lecture%2021 - Economics 102 Lecture 21: Open Economy Macro...

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