Lecture18 - Announcements: Today, Open Economy Macro...

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Announcements: Today, Open Economy Macro Readings for Open Economy Mankiw, ch 5, Mankiw, ch 12 PS #7 due Tuesday Nov 23 in lecture Exam scores/answers posted on Tuesday Outline for remainder of term Today and next Tuesday: Open Economy Week of Nov 29: Financial crisis, Banking, Monetary policy Week of Dec 6: Fiscal policy Short-run fiscal stimulus, Long-run fiscal challenges Open Economy International components of demand EX = exports IM = imports NX = EX – IM = net exports
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Open Economy NX = EX – IM = net exports Y = C + I + G + NX Y = domestic demand = domestic production National accounting avoids counting imported consumption, etc., as part of domestic demand Investment and saving in open economy Y = C + I + G + NX (Y – C – T ) + (T – G) – I = NX S – I = NX National saving – National Investment = Trade balance Investment and saving 2007, percent of national income Percent of Y National saving 14.0% National Investment 18.6% = Trade balance 4.6%
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Overview of building the open economy model: Parallels developments of closed-economy model • Small open economy Y at full employment [Mankiw ch 5] – fixed world interest rate ( r * ) and fixed real exchange rate fixed ( ε ) – determining real and nominal exchange rate Y not necessary at full employment – Mundell-Fleming model (Open economy IS- LM ) [Mankiw, ch. 12] • Two cases: fixed and floating exchange rates Trade balance given world interest rate Small open economy World conditions determine world interest rate Domestic interest rate equals world interest rate r = r * Æ Domestic investment a function of world interest rate Æ Trade balance: NX = S I ( r * ) National saving: The supply of loanable funds r S, I () SYCYT G =− − − S
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If the economy were closed… r S, I I ( ) S c = () …the interest rate would adjust to equate investment and saving: But in a small open economy… ( ) r* 1 the exogenous world interest rate determines investment… …and the difference between saving and investment determines net capital outflow and net exports NX Fiscal policy at home: Increase in G ( ) 1 1
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This note was uploaded on 12/31/2011 for the course ECON 402 taught by Professor House during the Fall '08 term at University of Michigan.

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Lecture18 - Announcements: Today, Open Economy Macro...

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