OPEN ECONOMY THEORY OF MACROECONOMIC Supply and Demand for Equilibrium in the Open Economy How Policies & Events affect an open economy Loanable funds Foreign Currency Exchange S = I + NCO All savers[.]
Trang 1OPEN ECONOMY - THEORY OF
MACROECONOMIC
Supply and Demand for
Equilibrium in the Open Economy
How Policies & Events affect an open economy
Loanable funds
Foreign - Currency Exchange
S = I + NCO
All savers go to this market to deposit their saving, and all borrowers go to this market to get their loans.
Supply: National Saving (S) Demand: Domestic Investment (I) + Net
Capital Outflow
(NCO)
Quantity demanded and
supplied depend on the
Real Interest Rate
Real Interest Rate:
higher
Supply: Increase
Demand: I: Decrease
NCO: Decrease
Real Interest Rate:
lower
Supply: Decrease Demand: I: Increase
NCO: Increase
Participants in this market trade U.S dollars in exchange for foreign currencies.
NCO = NX
Supply: Net Capital Outflow (NCO) Demand: Net Export (NX)
Quantity demanded
and supplied depend on
Real Exchange Rate
Real Exchange Rate:
appreciates
Supply: Net Capital
Capital Outflow:
unchanged
Demand: Decrease
Real Exchange Rate:
deppreciates
Supply: unchanged Demand: Increase
The key determinant
of NCO is the Real
Interest Rate.
=> Real Exchange Rate changes, there
will be no change in
NCO
Real Exchange Rate
(U.S.) appreciates,
U.S goods become more expensive relative to foreign
goods, exports
lower and imports more => reduce
the quantity of
dollars demanded.
*NCO is the link between 2 markets
Real Interest Rate
- higher: NCO decrease
- lower: NCO increase
Real Interest Rate & Real Exchange Rate determine:
National Saving (S), Domestic investment (I), Net Capital Outflow (NCO), Net Exports (NX)
Government Budget Deficit
T - G < 0
National Saving = Private Saving + Public Saving (Y - T - C) (T - G)
=> National Saving decrease
S (Loanable Funds) shift to left => Real Interest Rate increase => Net Capital Outflow (NCO) decrease => S
(Foreign-Currency Exchange) increase => Net Exports (NX) decrease
Trade deficit
The budget
deficit and the trade deficit are
often called the
twin deficits.
Trade policy
Government policy that directly influences the quantity of goods and services that a country imports or exports
2 common types
Tariffs (taxes on imported goods) Import quotas (limits on the quantity of goods
produced abroad that can be sold domestically)
Quotas have no effect on the market for
loanable funds => The real interest rate
will be unaffected.
Quotas lower import => NX increase => D1 shifts to D2
=> Real Exchange Rate increase => Export decrease => NX decrease
In the end, the quota reduces both
imports and exports but net exports
remain the same.
Trade policies do not affect the trade balance.
NX = S – I
Because trade policies do not affect S or I => cannot affect net exports.
Trade policies do have effects on
specific firms, industries, and countries.
But these effects are more
microeconomic than macroeconomic.
Political Instability and Capital Flight
Capital flight: a large and sudden reduction in the
demand for assets located in a country
Capital Flight => NCO (Mexican) increase => D (LF) increase
=> Real Interest Rate increase => Real Exchange Rate decrease => Value of Peso decrease
Equilibrium Interest Rate: the amount
people want to save = the amount people want to borrow to buy to buy Domestic Investment & Foreign assets.
Equilibrium Exchange Rate: the demand
for dollars to buy net exports exactly = the supply of dollars to be exchanged into foreign currency to buy assets abroad.