Chapter 28
Positive net exports: Net foreign investments Negative net exports: Foreign indebtedness is growing
Domestic expenditures equal to consumption plus domestic investment plus govt purchases. Difference between GDP and Domestic expenditures: 1. Some part of domestic expenditures will be on goods produced abroad. 2. Some part of domestic production will be sold abroad as exports
GDP
C + I +G +X
Exogenous materials like prices and exchange rates Domestic Income and output
Equilibrium output in an open economy occurs where total net domestic product and foreign spending equals total domestic output
The effect of a sustained increase in government spending (or investment) on incomethat is, the multiplieris smaller in an open economy than in a closed economy. The reason: When government spending (or investment) increases and income and consumption rise, some of the extra consumption spending that results is on foreign products and not on domestically produced goods and services
investments can flow easily among countries and the regulatory barriers to financial investments are low.
United States, Japan, countries of the European Union
will sell one currency and buy the other until the interest rates are equalized.
Monetary Easing
Monetary Easing
Monetary Easing
Net export expansion
4500 4000 3500 3000 2500 2000 1500 1000 500 0 1000 2000
C + I + G + X(e**)
C + I + G + X(e*)
Q*
3000
Q**
4000
Monetary Tightening
Monetary tightening
Recession
World real interest rate (rw): the real interest rate in the international capital market Key assumption: Residents of the small open economy can borrow or lend at the expected world real interest rate
saving over desired investment is lent internationally (net foreign lending is positive) and NX > 0 If rw = r2, then Sd = Id, so there is no net foreign lending and NX = 0 If rw = r3, then Sd < Id, so the excess of desired investment over desired saving is financed by borrowing internationally (net foreign lending is negative) and NX < 0
investment I) The foreign economy, representing the rest of the world (saving SFor, investment IFor)
The world real interest rate moves to equilibrate desired
international lending by one country with desired international borrowing by the other
determined such that a current account surplus in one country is equal in magnitude to the current account deficit in the other Changes in the equilibrium world real interest rate: Any factor that increases desired international lending of a country relative to desired international borrowing causes the world real interest rate to fall
Other issues
Trade policies Intellectual property rights Policies toward direct investment Overall macroeconomic climate
Most successful open economies: Europe: Netherlands, Luxembourg Asia: Taiwan, Hong Kong
Not only physical but also intangible capital Development of intellectual property rights
-taxes are reasonable and predictable and that inflation is low, so lenders need not worry about inflation confiscating their investments.
Low-Risk Country
High-Risk Country
appreciation of dollar produced severe hardships in many US sectors exposed to international trade. COMPETITIVENESS extent to which a nations goods can compete in the marketplace PRODUCTIVITY measured by the output per unit of input
Trends in Productivity
Importance of COMPETITION and OUTWARD
ORIENTATION Theory of Comparative Advantage nations are not inherently uncompetitive HIGH PRODUCTIVITY and HIGH LIVING STANDARDS = expose domestic industries to world markets and encourage them to adopt the most advanced technologies in the world
of predictability of relative prices while stabilizing the economy in the face of economic shocks Fixed exchange rate system subject of intense speculative attacks EU countries took the giant step of linking their economic fortunes through European Monetary Union, which forged a common currency, the Euro.
ties but also resolve the problem of unstable currencies that plagued the earlier fixed-exchange-rate systems. 11 European countries joined the EMU in 1999, these countries adopted the Euro as their unit of account and medium of exchange. European Central Bank conducts monetary policy for countries in the accord and thereby determine the interest rates for the Euro. PRIMARY OBJECTIVE of ECB: To pursue price stability Price Stability increase in Euroland consumer prices of below 2% per year over the medium term
FINAL ASSESSMENT
Robust economic performance - It is the period which these countries avoided deep
depression and the cancer of hyperinflation The emerging monetary system - Major economic regions with flexible exchange rate rates, while smaller countries either float or have hard fixed exchange rates The reemergence of free markets - Market-oriented countries of the West prospered while centrally planned command economies collapsed