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Depreciation and Trade Balance
• What is the impact of depreciation on trade?
– Import goods cost more
– Exports increases as they are cheaper abroad
– Imports decrease as they are expensive at home
• Overall impact on Net Exports (X-M) is that
it increases.
• Marshall-Lerner Condition: substitution
effect dominates income effect
Depreciation and Trade Balance
• Change in net export increases demand for
domestic goods
• Does reducing the trade deficit increase
output?
– In the short-run it does
– In the long-run not necessarily
• Fiscal contraction may compensate shortrun impact of depreciation (G)
• Shortcomings: a) source of depreciation; b)
why we care for GDP equilibrium
Depreciation and Trade Balance
• The J-Curve: compares impact effect of
depreciation and path to new equilibrium
– On impact nominal imports increase (due to
price effect)
– Then Marshall-Lerner condition kicks in
• There is a lag between real exchange rate
movements and trade balance (about 1year)
Saving = Investment
• In a Closed Economy domestic savings
equals investments
• In an Open Economy Investmet equals
“Total Savings”:
– Private Savings
– Government Savings
– Foreign Savings
Saving = Investment
• Y = C + I + G +X – M
– Since C = Y – S – T then
• Y = Y – SP – T + I + G + X – M
– Y cancels out; rearrange the rest and we get
• (SP) + (T-G) + (M-X) = I
– Private savings (SP) plus
– Government savings (T-G) plus
– Foreign Savings (balance of payments)
Saving = Investment
• Investment increase either with private
savings; government savings; or trade deficit
• Gov deficit affects either investment or
private savings or creates a trade deficit
• High private saving rate results either in high
investment ; trade surplus; or gov. surplus
• S=I also means that gov deficit does not lead
to trade deficit
U.S. Trade Deficit
• US X/GDP is quite constant through the years
• US M/GDP has been increasing through time
• Increasing trade deficit ($856bil; 6% of GDP);
half of world savings
• US has been growing more than EU and Japan
• Trade deficit increase even with appreciation
• Answer: increasing foreign savings
• During depreciation investment has stayed
constant while domestic saving has fallen. Why?