Throughout this book, we always express the nominal exchange rate as units of foreign currency per U.S.. If the exchange rate changes so that a dollar buys more foreign currency, that ch
Trang 1Mexican government has imposed, or might impose in the future, on foreign
investors in Mexico.
T H E E Q U A L I T Y O F N E T E X P O R T S
A N D N E T F O R E I G N I N V E S T M E N T
We have seen that an open economy interacts with the rest of the world in two
ways—in world markets for goods and services and in world financial markets.
Net exports and net foreign investment each measure a type of imbalance in these
markets Net exports measure an imbalance between a country’s exports and its
imports Net foreign investment measures an imbalance between the amount of
foreign assets bought by domestic residents and the amount of domestic assets
bought by foreigners.
An important but subtle fact of accounting states that, for an economy as a
whole, these two imbalances must offset each other That is, net foreign investment
(NFI) always equals net exports (NX):
NFI NX.
This equation holds because every transaction that affects one side of this equation
must also affect the other side by exactly the same amount This equation is an
identity—an equation that must hold because of the way the variables in the
equa-tion are defined and measured.
To see why this accounting identity is true, consider an example Suppose that
Boeing, the U.S aircraft maker, sells some planes to a Japanese airline In this sale,
a U.S company gives planes to a Japanese company, and a Japanese company
gives yen to a U.S company Notice that two things have occurred simultaneously.
The United States has sold to a foreigner some of its output (the planes), and this
sale increases U.S net exports In addition, the United States has acquired some
foreign assets (the yen), and this acquisition increases U.S net foreign investment.
Although Boeing most likely will not hold on to the yen it has acquired in this
sale, any subsequent transaction will preserve the equality of net exports and net
foreign investment For example, Boeing may exchange its yen for dollars with a
U.S mutual fund that wants the yen to buy stock in Sony Corporation, the
Japan-ese maker of consumer electronics In this case, Boeing’s net export of planes
equals the mutual fund’s net foreign investment in Sony stock Hence, NX and NFI
rise by an equal amount.
Alternatively, Boeing may exchange its yen for dollars with another U.S
com-pany that wants to buy computers from Toshiba, the Japanese computer maker In
this case, U.S imports (of computers) exactly offset U.S exports (of planes) The
sales by Boeing and Toshiba together affect neither U.S net exports nor U.S net
foreign investment That is, NX and NFI are the same as they were before these
transactions took place.
The equality of net exports and net foreign investment follows from the fact
that every international transaction is an exchange When a seller country transfers
a good or service to a buyer country, the buyer country gives up some asset to pay
for this good or service The value of that asset equals the value of the good or
ser-vice sold When we add everything up, the net value of goods and serser-vices sold by
a country (NX) must equal the net value of assets acquired (NFI) The international
Trang 2flow of goods and services and the international flow of capital are two sides of the same coin.
S AV I N G , I N V E S T M E N T, A N D T H E I R R E L AT I O N S H I P
T O T H E I N T E R N AT I O N A L F L O W S
A nation’s saving and investment are, as we have seen in Chapters 24 and 25, cru-cial to its long-run economic growth Let’s therefore consider how these variables are related to the international flows of goods and capital, as measured by net exports and net foreign investment We can do this most easily with the help of some simple mathematics.
As you may recall, the term net exports first appeared earlier in the book when
we discussed the components of gross domestic product The economy’s gross
domestic product (Y ) is divided among four components: consumption (C), investment (I ), government purchases (G), and net exports (NX ) We write
this as
Y C I G NX.
W ILL THE WORLD ’ SDEVELOPING COUN
-tries, such as those in Latin America,
flood the world’s industrial countries
with cheap exports while refusing to
import goods from the industrial
coun-tries? Will the developing countries use
the world’s saving to finance
invest-ment and growth, leaving the
indus-trial countries with insufficient funds
for their own capital accumulation?
Some people fear that both of these
out-comes might occur But an accounting
identity, and economist Paul Krugman,
tell us not to worry.
F a n t a s y E c o n o m i c s
B Y P AUL K RUGMAN Reports by international organizations are usually greeted with well deserved yawns Occasionally, however, such a report is a leading indicator of a sea change in opinion.
A few weeks ago, the World Eco-nomic Forum—which every year draws
an unmatched assemblage of the world’s political and business elite to its confer-ence in Davos, Switzerland—released its annual report on international compet-itiveness The report made headlines be-cause it demoted Japan and declared America the world’s most competitive economy.
The revealing part of the report, however, is not its more or less mean-ingless competitiveness rankings but its introduction, which offers what seems to
be a very clear vision of the global eco-nomic future.
That vision, shared by many power-ful people, is compelling and alarming It
is also nonsense And the fact that this nonsense is being taken seriously by many people who believe themselves to
be sophisticated about economics is it-self an ominous portent for the world economy.
The report finds that the spread
of modern technology to newly in-dustrializing nations is deinin-dustrializing high-wage nations: Capital is flowing to the Third World and low-cost produc-ers in these countries are flooding world markets with cheap manufactured goods.
The report predicts that these trends will accelerate, that service jobs will soon begin to follow the lost jobs in manufacturing and that the future of the high-wage nations offers a bleak choice between declining wages and rising un-employment.
This vision resonates with many people Yet as a description of what has
I N T H E N E W S
Flows between
the Developing South
and the Industrial North
Trang 3Total expenditure on the economy’s output of goods and services is the sum of
expenditure on consumption, investment, government purchases, and net exports.
Because each dollar of expenditure is placed into one of these four components,
this equation is an accounting identity: It must be true because of the way the
vari-ables are defined and measured.
Recall that national saving is the income of the nation that is left after paying
for current consumption and government purchases National saving (S) equals
Y C G If we rearrange the above equation to reflect this fact, we obtain
Y C G I NX
S I NX.
Because net exports (NX ) also equal net foreign investment (NFI ), we can write
this equation as
Saving investment Domestic Net foreign investment.
actually happened in recent years, it is
al-most completely untrue.
Rapidly growing Third World
econ-omies have indeed increased their
ex-ports of manufactured goods But today
these exports absorb only about 1
per-cent of First World income Moreover,
Third World nations have also increased
their imports.
Overall, the effect of Third World
growth on the number of industrial jobs
in Western nations has been minimal:
Growing exports to the newly
industrial-izing countries have created about as
many jobs as growing imports have
displaced.
What about capital flows? The
num-bers sound impressive Last year, $24
billion flowed to Mexico, $11 billion to
China The total movement of capital
from advanced to developing nations
was about $60 billion But though this
sounds like a lot, it is pocket change in a
world economy that invests more than
$4 trillion a year.
In other words, if the vision of a Western economy battered by low-wage competition is meant to describe today’s world, it is a fantasy with hardly any ba-sis in reality.
Even if the vision does not describe the present, might it describe the future?
Well, growing exports of manufactured goods from South to North will lead to a net loss of northern industrial jobs only if they are not matched by growth in ex-ports from North to South.
The authors of the report evidently envision a future of large-scale Third World trade surpluses But it is an un-avoidable fact of accounting that a coun-try that runs a trade surplus must also
be a net investor in other countries So large-scale deindustrialization can take place only if low-wage nations are major exporters of capital to high-wage na-tions This seems unlikely In any case, it contradicts the rest of the story, which predicts huge capital flows into low-wage nations.
Thus, the vision offered by the world competitiveness report conflicts not only with the facts but with itself Yet
it is a vision that a growing number of the world’s most influential men and women seem to share That is a dangerous trend.
Not everyone who worries about low-wage competition is a protectionist Indeed, the authors of the world compet-itiveness report would surely claim to be champions of free trade Nonetheless, the fact that such ideas have become re-spectable suggests that the intellec-tual consensus that has kept world trade relatively free, and that has allowed hun-dreds of millions of people in the Third World to get their first taste of prosper-ity, may be unraveling.
S OURCE: The New York Times, September 26, 1994,
p A17.
Trang 4C A S E S T U D Y ARE U.S TRADE DEFICITS
A NATIONAL PROBLEM?
You may have heard the press call the United States “the world’s largest debtor.” The nation earned that description by borrowing heavily in world fi-nancial markets during the 1980s and 1990s to finance large trade deficits Why did the United States do this, and should this event give Americans reason to worry?
To answer these questions, let’s see what these macroeconomic accounting identities tell us about the U.S economy Panel (a) of Figure 29-2 shows national saving and domestic investment as a percentage of GDP since 1960 Panel (b) shows net foreign investment as a percentage of GDP Notice that, as the identi-ties require, net foreign investment always equals national saving minus do-mestic investment.
The figure shows a dramatic change beginning in the early 1980s Before
1980, national saving and domestic investment were very close, and so net for-eign investment was small Yet after 1980, national saving fell dramatically, in part because of increased government budget deficits and in part because of a fall in private saving Because this fall in saving did not coincide with a similar fall in domestic investment, net foreign investment became a large negative number, indicating that foreigners were buying more assets in the United States than Americans were buying abroad Put simply, the United States was going into debt.
As we have seen, accounting identities require that net exports must equal net foreign investment Thus, when net foreign investment became negative, net exports became negative as well The United States ran a trade deficit:
plus its net foreign investment In other words, when U.S citizens save a dollar of their income for the future, that dollar can be used to finance accumulation of do-mestic capital or it can be used to finance the purchase of capital abroad.
This equation should look somewhat familiar Earlier in the book, when we analyzed the role of the financial system, we considered this identity for the spe-cial case of a closed economy In a closed economy, net foreign investment is zero
(NFI 0), so saving equals investment (S I) By contrast, an open economy has
two uses for its saving: domestic investment and net foreign investment.
As before, we can view the financial system as standing between the two sides
of this identity For example, suppose the Smith family decides to save some of its income for retirement This decision contributes to national saving, the left-hand side of our equation If the Smiths deposit their saving in a mutual fund, the mu-tual fund may use some of the deposit to buy stock issued by General Motors, which uses the proceeds to build a factory in Ohio In addition, the mutual fund may use some of the Smiths’ deposit to buy stock issued by Toyota, which uses the proceeds to build a factory in Osaka These transactions show up on the right-hand side of the equation From the standpoint of U.S accounting, the General Motors expenditure on a new factory is domestic investment, and the purchase of Toyota stock by a U.S resident is net foreign investment Thus, all saving in the U.S economy shows up as investment in the U.S economy or as U.S net foreign investment.
Trang 5Imports of goods and services exceeded exports In 1998, the trade deficit was
$151 billion, or about 1.8 percent of GDP.
Are these trade deficits a problem for the U.S economy? Most economists
believe that they are not a problem in themselves, but perhaps are a symptom
of a problem—reduced national saving Reduced national saving is potentially
a problem because it means that the nation is putting away less to provide for
its future Once national saving has fallen, however, there is no reason to
de-plore the resulting trade deficits If national saving fell without inducing a trade
deficit, investment in the United States would have to fall This fall in
invest-ment, in turn, would adversely affect the growth in the capital stock, labor
Percent
of GDP
20
18
16
14
12
10
National saving Domestic investment
Percent
of GDP
4
4
3
2
1
0
1
2
3
Net foreign investment
(a) National Saving and Domestic Investment (as a percentage of GDP)
(b) Net Foreign Investment (as a percentage of GDP)
2000
F i g u r e 2 9 - 2
N ATIONAL S AVING ,
D OMESTIC I NVESTMENT , AND
N ET F OREIGN I NVESTMENT Panel (a) shows national saving and domestic investment as
a percentage of GDP Panel (b) shows net foreign investment
as a percentage of GDP You can see from the figure that national saving has been lower since 1980 than it was before 1980 This fall
in national saving has been reflected primarily in reduced net foreign investment rather than in reduced domestic investment.
S OURCE : U.S Department of Commerce.
Trang 6not saving much, it is better to have foreigners invest in the U.S economy than
no one at all.
they are related.
T H E P R I C E S F O R I N T E R N AT I O N A L T R A N S A C T I O N S :
R E A L A N D N O M I N A L E X C H A N G E R AT E S
So far we have discussed measures of the flow of goods and services and the flow
of capital across a nation’s border In addition to these quantity variables, macro-economists also study variables that measure the prices at which these interna-tional transactions take place Just as the price in any market serves the important role of coordinating buyers and sellers in that market, international prices help co-ordinate the decisions of consumers and producers as they interact in world mar-kets Here we discuss the two most important international prices—the nominal and real exchange rates.
N O M I N A L E X C H A N G E R AT E S
The nominal exchange rate is the rate at which a person can trade the currency of
one country for the currency of another For example, if you go to a bank, you might see a posted exchange rate of 80 yen per dollar If you give the bank one U.S dollar, it will give you 80 Japanese yen; and if you give the bank 80 Japanese yen,
it will give you one U.S dollar (In actuality, the bank will post slightly different prices for buying and selling yen The difference gives the bank some profit for of-fering this service For our purposes here, we can ignore these differences.)
An exchange rate can always be expressed in two ways If the exchange rate is
80 yen per dollar, it is also 1/80 ( 0.0125) dollar per yen Throughout this book,
we always express the nominal exchange rate as units of foreign currency per U.S dollar, such as 80 yen per dollar.
If the exchange rate changes so that a dollar buys more foreign currency, that
change is called an appreciation of the dollar If the exchange rate changes so that
a dollar buys less foreign currency, that change is called a depreciation of the
lar For example, when the exchange rate rises from 80 to 90 yen per dollar, the dol-lar is said to appreciate At the same time, because a Japanese yen now buys less of the U.S currency, the yen is said to depreciate When the exchange rate falls from
80 to 70 yen per dollar, the dollar is said to depreciate, and the yen is said to ap-preciate.
At times you may have heard the media report that the dollar is either
“strong” or “weak.” These descriptions usually refer to recent changes in the
nom-inal exchange rate When a currency appreciates, it is said to strengthen because it
can then buy more foreign currency Similarly, when a currency depreciates, it is
said to weaken.
n o m i n a l e x c h a n g e r a t e
the rate at which a person can trade
the currency of one country for the
currency of another
a p p r e c i a t i o n
an increase in the value of a currency
as measured by the amount of foreign
currency it can buy
d e p r e c i a t i o n
a decrease in the value of a currency
as measured by the amount of foreign
currency it can buy
Trang 7For any country, there are many nominal exchange rates The U.S dollar can
be used to buy Japanese yen, British pounds, French francs, Mexican pesos, and so
on When economists study changes in the exchange rate, they often use indexes
that average these many exchange rates Just as the consumer price index turns the
many prices in the economy into a single measure of the price level, an exchange
rate index turns these many exchange rates into a single measure of the
interna-tional value of the currency So when economists talk about the dollar appreciating
or depreciating, they often are referring to an exchange rate index that takes into
account many individual exchange rates.
R E A L E X C H A N G E R AT E S
The real exchange rate is the rate at which a person can trade the goods and
ser-vices of one country for the goods and serser-vices of another For example, suppose
that you go shopping and find that a case of German beer is twice as expensive as
a case of American beer We would then say that the real exchange rate is 1/2 case
of German beer per case of American beer Notice that, like the nominal exchange
rate, we express the real exchange rate as units of the foreign item per unit of the
domestic item But in this instance the item is a good rather than a currency.
Real and nominal exchange rates are closely related To see how, consider an
example Suppose that a bushel of American rice sells for $100, and a bushel of
Japanese rice sells for 16,000 yen What is the real exchange rate between American
and Japanese rice? To answer this question, we must first use the nominal
ex-change rate to convert the prices into a common currency If the nominal exex-change
rate is 80 yen per dollar, then a price for American rice of $100 per bushel is
equiv-alent to 8,000 yen per bushel American rice is half as expensive as Japanese rice.
The real exchange rate is 1/2 bushel of Japanese rice per bushel of American rice.
We can summarize this calculation for the real exchange rate with the
follow-ing formula:
Using the numbers in our example, the formula applies as follows:
Real exchange rate
1/2 bushel of Japanese rice per bushel of American rice.
Thus, the real exchange rate depends on the nominal exchange rate and on the
prices of goods in the two countries measured in the local currencies.
Why does the real exchange rate matter? As you might guess, the real
ex-change rate is a key determinant of how much a country exports and imports.
When Uncle Ben’s, Inc., is deciding whether to buy U.S rice or Japanese rice to put
into its boxes, for example, it will ask which rice is cheaper The real exchange rate
8,000 yen per bushel of American rice 16,000 yen per bushel of Japanese rice
(80 yen per dollar) ($100 per bushel of American rice)
16,000 yen per bushel of Japanese rice
Nominal exchange rate Domestic price
Foreign price
r e a l e x c h a n g e r a t e
the rate at which a person can trade the goods and services of one country for the goods and services of another
Trang 8take a seaside vacation in Miami, Florida, or in Cancun, Mexico You might ask your travel agent the price of a hotel room in Miami (measured in dollars), the price of a hotel room in Cancun (measured in pesos), and the exchange rate be-tween pesos and dollars If you decide where to vacation by comparing costs, you are basing your decision on the real exchange rate.
When studying an economy as a whole, macroeconomists focus on overall prices rather than the prices of individual items That is, to measure the real ex-change rate, they use price indexes, such as the consumer price index, which mea-sure the price of a basket of goods and services By using a price index for a U.S.
basket (P), a price index for a foreign basket (P*), and the nominal exchange rate between the U.S dollar and foreign currencies (e), we can compute the overall real
exchange rate between the United States and other countries as follows:
Real exchange rate (e P)/P*.
This real exchange rate measures the price of a basket of goods and services avail-able domestically relative to a basket of goods and services availavail-able abroad.
As we examine more fully in the next chapter, a country’s real exchange rate is
a key determinant of its net exports of goods and services A depreciation (fall) in the U.S real exchange rate means that U.S goods have become cheaper relative to foreign goods This change encourages consumers both at home and abroad to buy more U.S goods and fewer goods from other countries As a result, U.S exports rise, and U.S imports fall, and both of these changes raise U.S net exports Con-versely, an appreciation (rise) in the U.S real exchange rate means that U.S goods have become more expensive compared to foreign goods, so U.S net exports fall.
explain how they are related ◆ If the nominal exchange rate goes from 100 to
120 yen per dollar, has the dollar appreciated or depreciated?
A F I R S T T H E O R Y O F E X C H A N G E - R AT E
D E T E R M I N AT I O N : P U R C H A S I N G - P O W E R PA R I T Y
Exchange rates vary substantially over time In 1970, a U.S dollar could be used to buy 3.65 German marks or 627 Italian lira In 1998, a U.S dollar bought 1.76 Ger-man marks or 1,737 Italian lira In other words, over this period the value of the dollar fell by more than half compared to the mark, while it more than doubled compared to the lira.
What explains these large and opposite changes? Economists have developed many models to explain how exchange rates are determined, each emphasizing just some of the many forces at work Here we develop the simplest theory of
ex-change rates, called purchasing-power parity This theory states that a unit of any
given currency should be able to buy the same quantity of goods in all countries Many economists believe that purchasing-power parity describes the forces that determine exchange rates in the long run We now consider the logic on which this
p u r c h a s i n g - p o w e r p a r i t y
a theory of exchange rates whereby a
unit of any given currency should
be able to buy the same quantity
of goods in all countries
Trang 9long-run theory of exchange rates is based, as well as the theory’s implications and
limitations.
T H E B A S I C L O G I C O F P U R C H A S I N G - P O W E R PA R I T Y
The theory of purchasing-power parity is based on a principle called the law of one
price This law asserts that a good must sell for the same price in all locations
Oth-erwise, there would be opportunities for profit left unexploited For example,
sup-pose that coffee beans sold for less in Seattle than in Boston A person could buy
coffee in Seattle for, say, $4 a pound and then sell it in Boston for $5 a pound,
mak-ing a profit of $1 per pound from the difference in price The process of takmak-ing
ad-vantage of differences in prices in different markets is called arbitrage In our
example, as people took advantage of this arbitrage opportunity, they would
in-crease the demand for coffee in Seattle and inin-crease the supply in Boston The price
of coffee would rise in Seattle (in response to greater demand) and fall in Boston
(in response to greater supply) This process would continue until, eventually, the
prices were the same in the two markets.
Now consider how the law of one price applies to the international
market-place If a dollar (or any other currency) could buy more coffee in the United States
than in Japan, international traders could profit by buying coffee in the United
States and selling it in Japan This export of coffee from the United States to Japan
Some of the currencies men-tioned in this chapter, such as the French franc, the German mark, and the Italian lira, are in the process of disappearing.
Many European nations have decided to give up their na-tional currencies and star t us-ing a new common currency
called the euro A newly formed
European Central Bank, with representatives from all of the par ticipating countries, issues the euro and controls the quantity in circulation, much as
the Federal Reser ve controls the quantity of dollars in the
U.S economy.
Why are these countries adopting a common currency?
One benefit of a common currency is that it makes trade
easier Imagine that each of the 50 U.S states had a
dif-ferent currency Ever y time you crossed a state border you
would need to change your money and per form the kind of
exchange-rate calculations discussed in the text This would
be inconvenient, and it might deter you from buying goods
and ser vices outside your own state The countries of
Europe decided that as their economies be-came more inte-grated, it would
be better to avoid this incon-venience.
There are, however, costs
of choosing a common cur-rency If the na-tions of Europe have only one money, they can have only one monetar y policy If they disagree about what monetar y policy is best, they will have to reach some kind of agreement, rather than each going its own way Because adopting a single money has both benefits and costs, there
is debate among economists about whether Europe’s recent adoption of the euro was a good decision Only time will tell what effect the decision will have.
F Y I
The Euro
Trang 10versely, if a dollar could buy more coffee in Japan than in the United States, traders could buy coffee in Japan and sell it in the United States This import of coffee into the United States from Japan would drive down the U.S price of coffee and drive
up the Japanese price In the end, the law of one price tells us that a dollar must buy the same amount of coffee in all countries.
This logic leads us to the theory of purchasing-power parity According to this theory, a currency must have the same purchasing power in all countries That is,
a U.S dollar must buy the same quantity of goods in the United States and Japan, and a Japanese yen must buy the same quantity of goods in Japan and the United
States Indeed, the name of this theory describes it well Parity means equality, and purchasing power refers to the value of money Purchasing-power parity states that a
unit of all currencies must have the same real value in every country.
I M P L I C AT I O N S O F P U R C H A S I N G - P O W E R PA R I T Y What does the theory of purchasing-power parity say about exchange rates? It tells
us that the nominal exchange rate between the currencies of two countries de-pends on the price levels in those countries If a dollar buys the same quantity of goods in the United States (where prices are measured in dollars) as in Japan (where prices are measured in yen), then the number of yen per dollar must reflect the prices of goods in the United States and Japan For example, if a pound of cof-fee costs 500 yen in Japan and $5 in the United States, then the nominal exchange rate must be 100 yen per dollar (500 yen/$5 100 yen per dollar) Otherwise, the purchasing power of the dollar would not be the same in the two countries.
To see more fully how this works, it is helpful to use just a bit of mathematics.
Suppose that P is the price of a basket of goods in the United States (measured in dollars), P* is the price of a basket of goods in Japan (measured in yen), and e is the
nominal exchange rate (the number of yen a dollar can buy) Now consider the quantity of goods a dollar can buy at home and abroad At home, the price level is
P, so the purchasing power of $1 at home is 1/P Abroad, a dollar can be exchanged into e units of foreign currency, which in turn have purchasing power e/P* For the
purchasing power of a dollar to be the same in the two countries, it must be the case that
1/P e/P*.
With rearrangement, this equation becomes
1 eP/P*.
Notice that the left-hand side of this equation is a constant, and the right-hand side
is the real exchange rate Thus, if the purchasing power of the dollar is always the same
at home and abroad, then the real exchange rate—the relative price of domestic and foreign goods—cannot change.
To see the implication of this analysis for the nominal exchange rate, we can rearrange the last equation to solve for the nominal exchange rate:
e P*/P.