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Open_Economy_Model - Open Economy Macroeconomics LONG RUN...

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Open Economy Macroeconomics – LONG RUN The level of real exchange rates ( Σ ), the relative price of domestically produced goods in terms of foreign goods, is determined by net supplies of and demands for dollars (or home country currency) generated by net purchases of assets and goods. Σ = eP/P F , where e is the nominal exchange rate (foreign exchange price of the dollar), P is the average price of U.S. goods and services, and P F is the average price of Foreign goods and services. The exchange rate adjusts so that (in the market for dollars or home currency): Quantity Demanded = Quantity Supplied where Quantity Demanded equals dollars demanded by foreigners to purchase U.S. assets [Stocks, Bonds, Direct Investment in Capital, etc. – CAPITAL INFLOWS (CI)] and dollars demanded to purchase U.S. produced goods and services [EXPORTS (EX)]. Quantity Supplied equals dollars supplied to purchase Foreign assets [CAPITAL OUTFLOWS (CO)] and dollars supplied to purchase foreign produced goods and services [IMPORTS (IM)].
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In the market for dollars the exchange rate adusts so that Quantity Demanded = Quantity Supplied CI + EX = CO + IM The overall Balance of Payments Surplus (B) is always equal to zero: B = [CI – CO] + [EX – IM] = 0 The Balance of Payments Surplus equals Net Capital Inflows (NCI), the Capital Account Surplus, plus Net Exports (NX), the Current Account Surplus. For a country such as Japan which is running a current account or trade surplus (NX) we have an offsetting capital account deficit (-NCI = NCO or Net Capital Outflows). The trade surplus generates a net demand for Yen seeking to purchase Japanese goods and services. The capital account deficit generates a net supply of Yen seeking to purchase foreign assets.
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Open_Economy_Model - Open Economy Macroeconomics LONG RUN...

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