Econ110BW11 - Lec17 A - GR_ol

Econ110BW11 - Lec17 A - GR_ol - Macroeconomics B Econ 110B...

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Macroeconomics B Econ 110B, Winter 2011 Prof. Giacomo Rondina Lecture 17
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The Open Economy ± A closer look at the decisions in the Open Economy ¾ Markets for Goods arkets for Assets ¾ Markets for Assets ± Equilibrium in the Market for Goods: the DD ZZ NX Diagram 2 Openness in Goods and Financial Markets (Ch. 18)
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Open Economy and Financial Markets Choice between Domestic and Foreign Assets Domestic Money Foreign Money Domestic Bonds Foreign Bonds t i How is this choice made? Invest $1 from period t to period t+1 $1 ( ) t i + * 1 / i E tt + 1 Domestic Bonds reign Bonds t E ( ) 1 €1 e t Ei + + Foreign Bonds ( ) * 1 i + + = No Arbitrage Condition: Uncovered Interest Parity (UIP) 3 1 t e t E + between Dollar and Euro Openness in Goods and Financial Markets (Ch. 18)
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Open Economy and Financial Markets Choice between Domestic and Foreign Assets ( ) * 1 1 1 tt t e t Ei i E + + += Uncovered Interest Parity (UIP) 4 Openness in Goods and Financial Markets (Ch. 18)
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Open Economy and Financial Markets Choice between Domestic and Foreign Assets ( ) * 1 1 1 tt t e t Ei i E + + += Uncovered Interest Parity (UIP) ± Sovereign Risk Compensation ( ) * 1 1 t e i λ + ++ = 1 t E + λ >0 : higher default risk in Foreign economy λ <0 : higher default risk in Domestic economy Example : Interest Rate Differentials in Euro Area ( ) * 11 i + ( ) 1 1 e EE + = = 5 * 1 1 t t ii i λλ + −= “spread” Openness in Goods and Financial Markets (Ch. 18)
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Sovereign Risk and 10 Year Yield Spreads 6 Openness in Goods and Financial Markets (Ch. 18) :Germany t i * :Other European Countries t i
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Open Economy and Financial Markets Choice between Domestic and Foreign Assets ( ) * 1 1 1 tt t e t Ei i E + + += Uncovered Interest Parity (UIP) ± Implicit Exchange Rate Expectations * 1 e EE ii + ≈− t E 7 Financial Markets and Expectations (Ch. 15)
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Open Economy and Financial Markets Choice between Domestic and Foreign Assets ( ) * 1 1 1 tt t e t Ei i E + + += Uncovered Interest Parity (UIP) ± Implicit Exchange Rate Expectations * 1 e EE ii + ≈− t E Expected Appreciation Rate of Domestic Currency 8 Financial Markets and Expectations (Ch. 15)
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Open Economy and Financial Markets Choice between Domestic and Foreign Assets ( ) * 1 1 1 tt t e t Ei i E + + += Uncovered Interest Parity (UIP) ±
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Econ110BW11 - Lec17 A - GR_ol - Macroeconomics B Econ 110B...

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