Chapter 31 -- Carlos Pitta

Recall nx s i nco a trade deficit means i s so the

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Recall, NX = S I = NCO . A trade deficit means I > S , so the nation borrows the difference from foreigners. In 2004, foreign purchases of U.S. assets exceeded U.S. purchases of foreign assets by $585 million. Such deficits have been the norm since 1980… 0
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U.S. Saving, Investment, and NCO 4% 8% 12% 16% 20% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 -6% -4% -2% 0% 2% 4% 6% 8% 10% Saving , Investment (% of GDP) Net Capital Outflow (% of GDP) Investment NCO (right scale) Saving 0
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CHAPTER 31 OPEN ECONOMY MACRO: BASIC CONCEPTS 21 Case Study:  The U.S. Trade Deficit Why U.S. saving has been less than investment: In the 1980s and early 2000s, huge budget deficits and low private saving depressed national saving. In the 1990s, national saving increased as the economy grew, but domestic investment increased even faster due to the information technology boom. 0
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CHAPTER 31 OPEN ECONOMY MACRO: BASIC CONCEPTS 22 Case Study:  The U.S. Trade Deficit Is the U.S. trade deficit a problem? The extra capital stock from the ’90s investment boom may well yield large returns The fall in saving of the ’80s and ’00s, while not desirable, at least did not depress domestic investment, as firms could borrow from abroad A country, like a person, can go into debt for good reasons or bad ones. A trade deficit is not necessarily a problem, but might be a symptom of a problem. 0
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CHAPTER 31 OPEN ECONOMY MACRO: BASIC CONCEPTS 23 Case Study:  The U.S. Trade Deficit as of 12-31-2004 People abroad owned $12.5 trillion in U.S. assets. U.S. residents owned $10 trillion in foreign assets. U.S.’ net indebtedness to other countries = $2.5 trillion. Higher than every other country’s net indebtedness. So, U.S. is “the world’s biggest debtor nation.” So far, the U.S. earns higher interest rates on foreign assets than it pays on its debts to foreigners. But if U.S. debt continues to grow, foreigners may demand higher interest rates, and servicing the debt would become a drain on U.S. income. 0
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CHAPTER 31 OPEN ECONOMY MACRO: BASIC CONCEPTS 24 The Nominal Exchange Rate Nominal exchange rate : the rate at which one country’s currency trades for another We express all exchange rates as foreign currency per unit of domestic currency. Some exchange rates as of 6 Jan 2006, all per US$ Canadian dollar: 1.16 Euro: 0.82 Japanese yen: 114.43 Mexican peso: 10.56 0
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CHAPTER 31 OPEN ECONOMY MACRO: BASIC CONCEPTS 25 Appreciation and Depreciation Appreciation (or “strengthening”): an increase in the value of a currency as measured by the amount of foreign currency it can buy Depreciation (or “weakening”): a decrease in the value of a currency as measured by the amount of foreign currency it can buy Examples: During 2005, the U.S. dollar… appreciated 15% against the euro depreciated 5% against the Mexican peso 0
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CHAPTER 31 OPEN ECONOMY MACRO: BASIC CONCEPTS 26 The Real Exchange Rate Real exchange rate : the rate at which the g&s of one country trade for the g&s of another Real exchange rate = where P = domestic price P* = foreign price (in foreign currency) e = nominal exchange rate, i.e., foreign currency per unit of domestic currency e x P P* 0
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