macroeconomics
fifth edition
N. Gregory Mankiw
PowerPoint® Slides
by Ron Cronovich
35%
30%
25%
20%
15%
10%
5%
0%
Canada France Germany Italy Japan Mexico U.K. USA
Imports Exports
source: OECD
(C C f ) (I I f ) (G G f ) EX
C I G EX (C f I f G f )
C I G EX IM
C I G NX
Y = C + I + G + NX
or, NX = Y – (C + I + G )
domestic
spending
net exports
output
NX = EX – IM = Y – (C + I + G )
trade surplus:
output > spending and exports > imports
Size of the trade surplus = NX
trade deficit:
spending > output and imports > exports
Size of the trade deficit = –NX
1%
0%
-1%
-2%
-3%
-4%
-5%
1975 1980 1985 1990 1995 2000
NX = Y – (C + I + G )
implies
NX = (Y – C – G ) – I
= S – I
trade balance = net capital outflows
Thus,
a country with a trade deficit (NX < 0)
is a net borrower (S < I ).
consumption function: C C (Y T )
investment function: I I (r )
exogenous policy variables: G G , T T
r S Y C (Y T ) G
As in Chapter 3,
national saving does
not depend on the
interest rate
S S, I
a & b imply r = r*
c implies r* is exogenous
r Investment is still a
downward-sloping function
of the interest rate,
but the exogenous
world interest rate…
r* …determines the
country’s level of
investment.
I (r )
I (r* ) S, I
I (rc ) S, I
S
CHAPTER 5 The Open Economy slide 16
But in a small open economy…
the exogenous r
S
world interest
rate determines
investment… NX
…and the r*
difference
between saving rc
and investment I (r )
determines net
capital outflows
I1 S, I
and net exports
NX1
Results:
I 0
NX S 0 I (r )
I1 S, I
Percent of GDP
4 8
Percent of GDP
3
(right scale) 6
2 4
1 2
0 0
-1 -2
-2 -4
-3 Net exports -6
(left scale)
-4 -8
-5 -10
1950 1960 1970 1980 1990 2000
Results:
I 0 I (r )
NX I 0
S, I
I (r )
2
*
I (r1* )
r*
EXERCISE:
Use the model to NX1
determine the impact
of an increase in
investment demand I (r )1
on NX, S, I, and net
capital outflow. I1 S, I
1973:1 = 100
2% 140
1% 120
0% 100
-1% 80
-2% 60
-3% 40
-4% 20
-5% 0
1975 1980 1985 1990 1995 2000
so U.S. net
When ε is exports will
relatively low, be high
U.S. goods are ε1
relatively
inexpensive NX(ε)
0 NX
NX(ε1)
CHAPTER 5 The Open Economy slide 33
The NX curve for the U.S.
ε At high enough
values of ε,
ε2 U.S. goods become
so expensive that
we export
less than
we import
NX(ε)
NX(ε2) 0 NX
Neither S nor I
ε S 1 I (r *)
depend on ε,
so the net
capital outflow
curve is vertical.
ε1
ε adjusts to
equate NX NX(ε )
with net capital
outflow, S I. NX
NX 1
supply: ε1
The net capital
outflow (S I ) NX(ε )
is the supply of
dollars to be NX
NX 1
invested abroad.
An increase in r* S 1 I (r1 *)
reduces investment, ε S 1 I (r2 *)
increasing net
capital outflows and ε
1
the supply of dollars
in the foreign
exchange market… ε 2
An increase in S1 I 2
investment ε S1 I 1
reduces net
capital outflows
ε2
and the supply
of dollars in the
foreign exchange ε1
market…
NX(ε )
…causing the
NX
real exchange NX 2 NX 1
rate to rise and
NX to fall.
CHAPTER 5 The Open Economy slide 41
4. Trade policy to restrict imports
Results:
ε S I
ε > 0
(demand
increase) ε2
NX = 0
(supply fixed) ε1
IM < 0 NX (ε )2
(policy)
NX (ε )1
EX < 0
(rise in ε ) NX
NX1
P*
e ε
P
M
L (r * , Y )
NX (ε ) S I (r *) P
e ε P *
P ε
For a given value of ε,
the growth rate of e equals the difference
between foreign and domestic inflation rates.
NX
CHAPTER 5 The Open Economy slide 50
Does PPP hold in the real world?
No, for two reasons:
1. International arbitrage not possible.
nontraded goods
transportation costs
2. Goods of different countries not perfect
substitutes.
Nonetheless, PPP is a useful theory:
• It’s simple & intuitive
• In the real world, nominal exchange rates
have a tendency toward their PPP values over
the long run.
CHAPTER 5 The Open Economy slide 51
CASE STUDY
The Reagan Deficits revisited
actual closed small open
1970s 1980s
change economy economy
G–T 2.2 3.9
S 19.6 17.4
r 1.1 6.3 no change
I 19.9 19.4 no change
NX -0.3 -2.0 no change
ε 115.1 129.4 no change
Data: decade averages; all except r and ε are expressed
as a percent of GDP; ε is a trade-weighted index.
CHAPTER 5 The Open Economy slide 52
The U.S. as a large open economy
So far, we’ve learned long-run models for
two extreme cases:
closed economy (chapter 3)
small open economy (chapter 5)
A large open economy --- like the U.S. --- is
in between these two extremes.
The analysis of policies or other exogenous
changes in a large open economy is a mixture of
the results for the closed & small open economy
cases.
For example…
CHAPTER 5 The Open Economy slide 53
A fiscal expansion in three models
A fiscal expansion causes national saving to fall.
The effects of this depend on the degree of openness:
closed large open small open
economy economy economy
rises, but not as much no
r rises
as in closed economy change
falls, but not as much no
I falls
as in closed economy change
no falls, but not as much as
NX falls
change in small open economy