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Chapter 12 - Open Economy Macroeconomics.pdf

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Simon Fraser University
ECON 105
Brian Krauth

Chapter 12 - Open Economy Macroeconomics Friday, November 09, 2012 1:24 PM Recall y= C + I + G + NX NX = exports - imports Let NCO ( net capital outflow ) Be (total purchase of foreign assets by domestic residents) - (total purchase of domestic assets by foreign residents) = (total capital outflow) - (total capital inflow) As an accounting identity • NX = NCO Back to savings and investment • Recall that in a closed economy(NX=0) ○ Y= C+I + G + NX ○ S^private = Y - T - C ○ S^public = T - G ○ S = S^private + S^public ○ ( Y - T- C ) + ( T - G) ○ Y - C -G ○ = I • In an open economy(NX not equal to 0) ( NX = NCO) ○ S = Y - C - G ○ C + I + G + NX - C - G ○ I + NX ○ S = I + NCO or I = S - NCO • Example: US in recent years has had ○ Low savings rate ○ High investmentrates I > 0 ○ Large trade deficits NX < 0 The nominal interest rate is the amount of foreign currency that can be purchased with one unit of domesticcurrency. Example: March 12, 2012 $1 canadian = $1.01 = $1.01 0.766Euros We say that a currency appreciates when its value goes up, and depreciates when its value goes down. Currencies always appreciate or depreciate relative to someother currency. BoC does report the value of the canadian dollar relative to a trade- weighted basket of currencies. The real exchange rate is the amount of foreign goods that can be purchased with one unit of domestic goods. P = domestic price level P^* = foreign price level (in foreign currency) Suppose I sell 1 unit of goods domestically.I get P Canadian dollars. I can exchange for eP units of foreign currency, and use that money to buy eP/ P* units of foreign goods. So real exchange rates = eP / P* Two Theories Two Theories Purchasing Power Parity ( PPP) The theory of PPP holds that the real exchange rate is 1 ( or may just be a constant) PPP is an impli
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