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Econ110BW11 - Lec14 A - GR_ol

Econ110BW11 - Lec14 A - GR_ol - Macroeconomics B Econ 110B...

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Unformatted text preview: Macroeconomics B Econ 110B, Winter 2011 Prof. Giacomo Rondina Lecture 14 The Open Economy Trade is in goods, services and capital (financial assets). Outcome of economic policies depend on international trade. How do economic policies change in the open economy? H d i li i h i h ? Openness in Goods and Financial Markets (Ch. 18) 2 Financial Globalization Openness in Goods and Financial Markets (Ch. 18) 3 Financial Globalization: Emerging Markets Russia Mexico Brazil India China Argentina Openness in Goods and Financial Markets (Ch. 18) 4 Financial Globalization Openness in Goods and Financial Markets (Ch. 18) 5 Financial Globalization and International Trade Openness in Goods and Financial Markets (Ch. 18) 6 Financial Globalization and International Trade Flow of Financial Capital from Emerging Markets (Asia) Trade Deficit (high imports) How are these two stylized facts related? Let's see if the TwoPeriod model can help.... Openness in Goods and Financial Markets (Ch. 18) 7 Financial Globalization and International Trade Terminology "Domestic": of the home country (U.S. in our case) "Foreign": of the foreign country (rest of the world) Examples: domestic output, domestic interest rate, foreign p , g , g p , output, foreign interest rate, foreign expected inflation, domestic currency, foreign currency, etc. Openness in Goods and Financial Markets (Ch. 18) 8 The TwoPeriod Model and the Open Economy Agent Aggregate Economy (e.g. U.S.) Today Future Income (GDP) YUS Y'US Consumption (Aggregate) CUS Consumption (Aggregate) C C C'US Saving (Aggregate) SUS -SUS (1+r) Suppose that, to have CUS=C'US i S h h C C' it must be CUS > YUS ( b C (e.g. when Y'US>> YUS) h How can an economy consume more than it produces? If "Closed" Economy it cannot! Therefore CUS = YUS and C'US = Y'US : autarky allocation. If "Open" Economy it can! By Importing goods from the rest of the world. Therefore CUS YUS and C'US Y'US : open economy allocation. Openness in Goods and Financial Markets (Ch. 18) 9 The TwoPeriod Model and the Open Economy Agent Aggregate Economy (e.g. U.S.) Today Future Income (GDP) YUS Y'US Consumption (Aggregate) CUS Consumption (Aggregate) C C C'US Saving (Aggregate) SUS -SUS (1+r) Suppose that, to have CUS=C'US i S h h C C' it must be CUS > YUS . b C Let CA (Current Account) = X (Exports)-IM (Imports) In the "twoperiod" model for an open economy one has CAUS= XUS-IMUS= SUS = YUS -CUS IM C If CUS > YUS then SUS= CAUS < 0 (economy (US) is borrowing) If CUS < YUS then SUS= CAUS > 0 (economy (US) is lending) Openness in Goods and Financial Markets (Ch. 18) 10 Current Account Balance for the US, 19602010 CAUS(Current Account) = XUS(Exports)-IMUS(Imports)<0 The US have been borrowing from the rest of the world from 1990. Openness in Goods and Financial Markets (Ch. 18) 11 Net Capital Inflow (Foreign Capital) If C If CUS > YUS then SUS= CAUS < 0 (Country (US) is borrowing) then S CA (C t i b i ) Openness in Goods and Financial Markets (Ch. 18) 12 Foreign Capital and Trade Deficit If C If CUS > YUS then SUS= CAUS < 0 (Country (US) is borrowing) then S CA (C t i b i ) Openness in Goods and Financial Markets (Ch. 18) 13 The TwoPeriod Model and the Open Economy Agent Aggregate Economy (e.g. U.S.) Today Future Income (GDP) YUS Y'US Consumption (Aggregate) CUS Consumption (Aggregate) C C C'US Saving (Aggregate) SUS -SUS (1+r) Current Account CAUS CA'US Is CAUS <0 bad for the economy? SUS= CAUS < 0 and SUS is chosen by the agents to smooth consumption! It does have implications for the future. Intertemporal Budget Constraint CUS + CUS Y = YU S + U S C AU S = - C AU S (1 + r ) 1+ r 1+ r If CAUS < 0 then CA'US > 0 (saving in the future) If CAUS > 0 then CA'US < 0 (dissaving in the future) Openness in Goods and Financial Markets (Ch. 18) 14 Current Account Balance for the US, 19602010 From IBC: CA'US(Current Account) >0 The US will have to save (consume less than produced) at some point in the future. Openness in Goods and Financial Markets (Ch. 18) 15 Open Economy: the Balance of Payments (Simplified Version) t t+1 t t+1 Current Account Exports (X) Imports (IM) Trade Balance (1) = (X) ( ) ( ) ( ) (IM) Current Account Balance = CA Capital Account Capital Account Increase in foreign holdings of U.S. assets (4) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA How to report international transactions at t for the TwoPeriod model? Openness in Goods and Financial Markets (Ch. 18) 16 Open Economy: the Balance of Payments (Simplified Version) t t+1 t t+1 Current Account Exports (X) Imports (IM) Trade Balance (1) = (X) ( ) ( ) ( ) (IM) Current Account Balance = CA YC Capital Account Capital Account Increase in foreign holdings of U.S. assets (4) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA S How to report international transactions at t for the TwoPeriod model Openness in Goods and Financial Markets (Ch. 18) 17 Open Economy: the Balance of Payments (Simplified Version) t t+1 t t+1 Current Account Exports (X) Imports (IM) Trade Balance (1) = (X) ( ) ( ) ( ) (IM) Current Account Balance = CA YC>0 Capital Account Capital Account Increase in foreign holdings of U.S. assets (4) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA S<0 How to report international transactions at t for the TwoPeriod model Openness in Goods and Financial Markets (Ch. 18) 18 Open Economy: the Balance of Payments (Simplified Version) t t+1 t t+1 Current Account Exports (X) Imports (IM) Trade Balance (1) = (X) ( ) ( ) ( ) (IM) Current Account Balance = CA YC<0 Capital Account Capital Account Increase in foreign holdings of U.S. assets (4) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA S>0 How to report international transactions at t for the TwoPeriod model Openness in Goods and Financial Markets (Ch. 18) 19 Open Economy: the Balance of Payments (Simplified Version) t t+1 t t+1 Current Account Exports (X) Imports (IM) Trade Balance (1) = (X) ( ) ( ) ( ) (IM) Current Account Balance = CA YC Y'C' Capital Account Capital Account Increase in foreign holdings of U.S. assets (4) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA S S(1+r) How to report international transactions at t for the TwoPeriod model Openness in Goods and Financial Markets (Ch. 18) 20 Open Economy: the Balance of Payments (Simplified Version) t t+1 t t+1 Current Account Exports (X) Imports (IM) Trade Balance (1) = (X) ( ) ( ) ( ) (IM) Current Account Balance = CA YC Y'C'>0 Capital Account Capital Account Increase in foreign holdings of U.S. assets (4) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA S S(1+r)<0 How to report international transactions at t for the TwoPeriod model Openness in Goods and Financial Markets (Ch. 18) 21 Open Economy: the Balance of Payments (Simplified Version) t t+1 t t+1 Current Account Exports (X) Imports (IM) Trade Balance (1) = (X) ( ) ( ) ( ) (IM) Current Account Balance = CA YC Y'C'<0 Capital Account Capital Account Increase in foreign holdings of U.S. assets (4) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA S S(1+r)>0 How to report international transactions at t for the TwoPeriod model Openness in Goods and Financial Markets (Ch. 18) 22 Open Economy: the Balance of Payments (BoP) Current Account Exports (X) $1,500 (b) Exports (X) $1 500 (b) Imports (IM) $2,000 (a) Trade Balance (1) = (X) (IM) Investment Income Received (IR) Investment Income Paid (IP) ( ) Net Investment Income (2) = (IR) (IP) Net Transfers Received (3) Current Account Balance = (1) + (2) + (3) = CA $500 Capital Account Increase in foreign holdings of U.S. assets (4) $2,000 (a) $1,500 (b) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA +$500 Statistical Discrepancy (adjustment due to measurement errors) Example 1 Example 1 (a) US consumer imports $2,000 leather shoes from Italy, pays with $2,000 US bonds. (b) Dell sells a computer in Italy for $1,500, gets paid $1,500 in cash (dollars). Record these transaction in the BOP. Openness in Goods and Financial Markets (Ch. 18) 23 Open Economy: the Balance of Payments (BoP) Current Account Exports (X) Exports (X) Imports (IM) Trade Balance (1) = (X) (IM) Investment Income Received (IR) Investment Income Paid (IP) ( ) Net Investment Income (2) = (IR) (IP) Net Transfers Received (3) Current Account Balance = (1) + (2) + (3) = CA Capital Account Increase in foreign holdings of U.S. assets (4) $5,000 (dollars used for payment) Increase in U.S. holdings of foreign assets (5) $5,000 (FIAT stocks held by US investor) Capital account balance = (4) (5) = KA $ 0 Statistical Discrepancy (adjustment due to measurement errors) Example 2 Example 2 US investor buys $5,000 stocks of FIAT (Italian Automaker) on the Italian stock market, pays in cash (dollars). Record this transaction in the BoP h h Openness in Goods and Financial Markets (Ch. 18) 24 Open Economy: the Balance of Payments Current Account Exports (X) Exports (X) Imports (IM) Trade Balance (1) = (X) (IM) Investment Income Received (IR) $100 (dividends received) Investment Income Paid (IP) ( ) Net Investment Income (2) = (IR) (IP) Net Transfers Received (3) Current Account Balance = (1) + (2) + (3) = CA Capital Account Increase in foreign holdings of U.S. assets (4) $100 (dollars used for payment) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA Statistical Discrepancy (adjustment due to measurement errors) Example 3 Example 3 FIAT stocks held by US investor pay $100 in dividends, in cash (dollars). Record this transaction in the BoP Openness in Goods and Financial Markets (Ch. 18) 25 Open Economy: the Balance of Payments Current Account Exports (X) Exports (X) Imports (IM) Trade Balance (1) = (X) (IM) Investment Income Received (IR) Investment Income Paid (IP) ( ) Net Investment Income (2) = (IR) (IP) Net Transfers Received (3) $1M (aid given) Current Account Balance = (1) + (2) + (3) = CA Capital Account Increase in foreign holdings of U.S. assets (4) $1M (dollars used for payment) Increase in U.S. holdings of foreign assets (5) Capital account balance = (4) (5) = KA Statistical Discrepancy (adjustment due to measurement errors) Example 4 Example 4 US Government donates aid resources to developing countries for $1M, in cash (dollars) Record this transaction in the BoP Openness in Goods and Financial Markets (Ch. 18) 26 ...
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