Download Open-economy Macroeconomics

Open-economy
Macroeconomics
National output
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{
We start with the Keynesian model
Recall a simple Keynesian model
implies prices are fixed.
National income and foreign trade
----in a flexible exchange rate regime
Open economy macroeconomics
{
Our previous discussion assmes
z
z
z
z
{
Prices are fixed
Exchange rate is fixed
Interest rate is fixed
No capital mobility
{
{
{
{
Domestic absorption defined as
{
Aggregate Expenditure
z
z
A=C+I+G
AE = A + X - J
Now we first relax the fixed
exchange rate assumption
Determinants of Current and Capital
Accounts
{
Open economy macroeconomics
Net Exports NX = X – J
Exchange rate and export
An increase in exchange rate, a
depreciation of dollar, causes export
to increase
X (e):
z
e↑ ⇒ X ↑
z
Xe > 0
Determinants of Current and Capital
Accounts
{
{
{
Imports are affected by the
exchange rate and domestic
absorption
An exchange rate increase, or dollar
depreciation, cause imports to go
down
J (e, A):
z
z
e↑ ⇒ J ↓
Je < 0
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Determinants of Current and Capital
Accounts
{
{
Increase in domestic absorption
causes imports to increase
J (e, A):
z
z
z
A↑ ⇒ J ↑
External Balance
{
z
{
{
JA > 0
JA < 1
{
{
External Balance
{
External Balance
NX = X(e) – J (e, A) = 0
External balance means that the
trade is balanced.
If e goes up, NX goes up.
To maintain the external balance, A
should also go up, to increase
imports and reduce NX.
de/dA > 0
External balance
Totally differentiate external Balance
NX = X(e) – J (e, A) = 0
e
External balance (EB)
X-J=0
X e de − J e de − J A dA = 0
( X e − J e ) de = J A dA
de
JA
(+ )
=
=
>0
dA X e − J e (+ ) − (−)
0
External balance
Internal Balance
{
e
External balance (EB)
X-J=0
CA surplus
{
{
CA deficit
{
0
A
A
{
Internal Balance is reached when
the aggregate expenditure equals
potential GDP
That is, in the state of full
employment
Yp=potential GDP = AE
Yp = A + X(e) – J(e,A)
Note, Yp is exogeneous.
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Internal Balance
{
Totally differentiate internal Balance
z
Yp = A + X(e) – J (e, A)
Internal balance
A+X-J=AE=Yp
Internal balance (IB)
e
0 = dA + X e de − J e de − J A dA
= ( X e − J e )de + (1 − J A )dA
de − X e + J e −(+) + (−)
=
=
<0
1− J A
(+ )
dA
Internal Balance
{
{
{
Insight:
If domestic absorption A is too
small hence the AE is less than
potential GDP, it results in
recession.
Then it needs e to go up, to
stimulate the net export, in order to
reach the full employment (internal
balance).
Equilibrium
{
Equilibrium is the state where the
economy reaches both the internal
and external equilibrium.
A
0
Internal balance
A+X-J=AE=Yp
Internal balance (IB)
e
Inflation
recession
A
0
Equilibrium
e
IB
Inflation
EB
CA surplus
Recession
Inflation
CA surplus
CA deficit
Recession
CA deficit
0
A
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Internal and external balance
{
To reach both internal and external
equilibriums, we need adjust both
policy instruments
z
z
{
Adjusting domestic absorption A
Adjusting exchange rate e
Cannot relying on only one
instrument.
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