The Open Economy CHAPTER FIVE

Presentation on theme: "The Open Economy CHAPTER FIVE"— Presentation transcript:

1 The Open Economy CHAPTER FIVE
Chapter 5 extends the analysis to a small open economy. There is a new case study in the early part of (the PowerPoint presentation of) this chapter on the U.S. being the world’s largest debtor nation. (Though the relevant slide is not titled “case study.”) This material will help motivate the rest of the chapter: First, students learn exactly what trade surpluses and trade deficits are. Next, students learn the link between the trade balance and net capital outflows or net lending to/borrowing from abroad. Finally, students see a new time series graph on the U.S. trade deficit, and get the latest available numbers on U.S. net indebtedness to the rest of the world. This data begs the question: how did it come to this? why has the U.S. had such huge trade deficits? what can the government do about this? These are among the many topical questions that students will better understand as they study this chapter. NOTE: If you are planning on covering chapter 12 (Aggregate Demand in the Open Economy), then covering this chapter is highly recommended.

2 Chapter objectives 개방경제에서의 국민소득계정 항등식 소국의 개방경제 모형 “small”, 소국이란
무역수지와 환율의 결정 trade balance & exchange rate에 영향을 주는 정책

3 개방경제 에서는 소비가 생산과 일치하지 않을 수 있다. 국내저축과 국내투자가 일치하지 않을 수 있다.
Regarding “spending need not equal output”: Residents of an open economy can spend more than the country’s output simply by importing foreign goods. Residents can spend less than output, and the extra output will be exported. Regarding “saving need not equal investment”: If individuals in an open economy want to save more than domestic firms want to borrow, no problem. The savers simply send their extra funds abroad to buy foreign assets. Similarly, if domestic firms want to borrow more than individuals are willing to save, then the firms simply borrow from abroad (i.e. sell bonds to foreigners).

4 Preliminaries EX = exports = 수출 IM = imports = C f + I f + G f = 수입
superscripts: d = 국내생산품 수요 f = 국외생산품 수요 EX = exports = 수출 IM = imports = C f + I f + G f = 수입 NX = net exports (순수출) = EX – IM Before displaying the second and subsequent lines, explain the first one: Total consumption expenditure is the sum of consumer spending on domestically produced goods and foreign produced goods. EX: The value of the goods we export to other countries equals their expenditure on our output. IM: The value of our imports equals the portion of our country’s expenditure (the portion of C+I+G) that falls on foreign products.

5 GDP (지출) A country’s GDP is total expenditure on its output of final goods & services. The first line adds up all sources of spending on domestically produced goods & services. The second & subsequent lines present an algebraic derivation of the national income accounting identity for an open economy.

6 개방경제의 국민소득 항정식 Y = C + I + G + NX or, NX = Y – (C + I + G ) 국내소비 순수출
총생산 국내소비 순수출 Solving this identity for NX yields the second equation, which says: A country’s net exports---its net outflow of goods---equals the difference between its output and its expenditure. Example: If we produce $500b worth of goods, and only buy $400b worth, then we export the remainder. Of course, NX can be a negative number, which would occur if our spending exceeds our income/output.

7 무역수지 흑자와 적자 NX = EX – IM = Y – (C + I + G ) 무역수지 흑자:NX
생산 > 소비 and 수출 > 수입 무역수지적자: –NX 소비 > 생산 and 수입 > 수출

8 국제간 자금이동 순자본유출 S – I net outflow of “대출가능 자금” 외화자산의 순취득
When S > I, 해외 투자국 When S < I, 해외 차입국 In chapter 3, we examined a closed economy model of the loanable funds market. Savers could only lend money to domestic borrowers. Firms borrowing to finance their investment could only borrow from domestic savers. Thus, S = I. But in an open economy, S need not equal I. A country’s supply of loanable funds can be used to finance domestic investment, or to finance foreign investment (e.g. buying bonds from a foreign company that needs funding to build a new factory in its country). Similarly, domestic firms can finance their investment projects by borrowing loanable funds from domestic savers or by borrowing them from foreign savers. International borrowing and lending is called “international capital flows” even though it’s not the physical capital that is flowing abroad --- we don’t see factories uprooted and shipped to Mexico (Ross Perot’s famous remark notwithstanding). Rather, what can flow internationally is “loanable funds,” or financial capital, which of course is used to finance the purchase of physical capital. Note: foreign investment might involve the purchase of financial assets – stocks and bonds and so forth – or physical assets, such as direct ownership in office buildings or factories. In either case, a person in one country ends up owning part of the capital stock of another country. The equation NFI = S – I shows that, if a country’s savers supply more funds than its firms wish to borrow for investment, the excess of loanable funds will flow abroad in the form of net foreign investment (the purchase of foreign assets). Alternatively, if firms wish to borrow more than domestic savers wish to lend, then the firms borrow the excess on international financial markets; in this case, there’s a net inflow of loanable funds, and NFI < 0.

9 무역수지와 순자본유출과의 관계 그러므로, 무역적자국은 (NX < 0) 순자본유출국 (S < I ).
NX = Y – (C + I + G ) implies NX = (Y – C – G ) – I = S – I trade balance = net capital outflows Starting from the equation derived on slides 6 and 7, we can derive another important identity: NX = S – I This equation says that Net exports (the net outflow of goods) = net capital outflows (the net outflow of loanable funds) While the identity and its derivation are very simple, we learn a very important lesson from it: A country (such as the U.S.) with persistent, large trade deficits (NX < 0) also has low saving, relative to its investment, and is a net borrower of assets. 그러므로, 무역적자국은 (NX < 0) 순자본유출국 (S < I ).

10 소국개방경제의 저축과 투자 제3장의 대부자금시장을 참조

11 3장에서 보았듯이 자금의 공급은 이자율의 함수가 아니다
국내 저축: 대부자금의 공급 r S, I 3장에서 보았듯이 자금의 공급은 이자율의 함수가 아니다

12 c implies r* is exogenous
자본의 흐름에 대한 가정 국내외 금융상품은 완전한 대체재: 위험도, 만기 등 완전한 자본이동: no restrictions on international trade in assets 소국 경제: 때문에 세계이자율 (r*)에 영향을 미칠 수 없다. a & b imply r = r* c implies r* is exogenous This slide is the first on which students see a foreign variable, in this case, the foreign interest rate r*. In general, a “*” on a variable denotes the foreign or world version of that variable. Thus, Y* = foreign GDP, P* = foreign price level, etc. The assumption that domestic & foreign bonds are perfect substitutes is implicit in the text, but necessary for the equality of the domestic and foreign interest rate. Students will realize that assumption a is unrealistic, and c is unrealistic for the U.S. (as well as Japan and the Euro zone). However, these assumptions keep our model simple, and we can still learn a LOT about how the world works (just as the model of supply and demand in perfectly competitive markets is not realistic, yet teaches us a great deal about how the world works). At the end of the chapter, there’s a brief section discussing how the results we are about to derive differ in a large open economy. And you may wish to have your students read the appendix to chapter 5, which presents a formal model of the large open economy.

13 투자: 대부자금의 수요 r S, I 투자는 이자율의 함수이며 서로 부의 관계이다. (downward-sloping)
투자: 대부자금의 수요 투자는 이자율의 함수이며 서로 부의 관계이다. (downward-sloping) r S, I I (r ) 그러나 국외 시장의 외생적 이자율이 r * 국내투자를 결정한다 I (r* )

14 If 폐쇄경제 라면.. r S, I …실질이자율이 저축과 투자를 균형시킴 I (r ) rc

15 But in a small open economy…
r S, I 외생변수인 세계이자율이 투자 결정… I (r ) NX r* I 1 …따라서 저축과 투자의 차이는 순자본 유출과 무역수지이다 rc This graph really determines net capital outflows, not NX. But, the national accounting identities say that NX = net capital outflows, so we write “NX” on the graph as shown. A little bit later in the chapter, we will see that it is the adjustment of the exchange rate that ensures that NX = net capital outflows. For now, though, students will just have to trust the accounting identities.

16 세가지 실험 2. 해외 재정정책 3. 투자수요의 증가 1. 국내 재정정책
1. 국내 재정정책 2. 해외 재정정책 3. 투자수요의 증가 In the textbook, NX = 0 in the economy’s initial equilibrium for each of these three experiments. In these slides, NX > 0 in the initial equilibrium. For completeness, you might have your students repeat the three experiments for the case of NX < 0 in the initial equilibrium. This would be a good homework or in-class exercise.

17 1. 국내재정정책 r S, I I (r ) I 1 재정지출 증가 G 혹은 세금감면 T - reduces saving. 결과:
1. 국내재정정책 r S, I 재정지출 증가 G 혹은 세금감면 T - reduces saving. I (r ) NX2 I 1 NX1 결과: In a small open economy, the fixed world interest rate pins down the value of investment, regardless of fiscal policy changes. Thus, a $1 decrease in saving causes a $1 decrease in NX and net capital outflows. Note that the analysis on this slide applies to ANYTHING that causes a decrease in saving. Other examples: a shift in consumer preferences regarding the tradeoff between saving and consumption, or a change in the tax laws that reduces the incentive to save. Our model generates a prediction: the government’s budget deficit and the country’s trade balance should be negatively related. Does this prediction come true in the real world? Let’s look at the data….

18 2. 해외재정정책 r S, I I (r ) 국외재정팽창정책 Results: NX2 NX1
It might be worth taking a moment to explain that the world interest rate r* is determined by saving and investment in the world loanable funds market. S* is the sum of all countries’ saving; I* the sum of all countries’ investment. r* adjusts to equate I* with S*, just like in Chapter 3, because the world as a whole is a closed economy. A fiscal expansion in other countries would reduce S* and raise r* (same results as in chapter 3). The higher world interest rate reduces investment in our small open economy, and hence reduces the demand for loanable funds. The supply of loanable funds (national saving) is unchanged, so there’s an increase in the amount of funds flowing abroad.

19 3. 투자수요의 증가 r S, I S I (r )1 I 1 NX1 연습: 투자수요증가의(shift) 효과는?- NX, S, I, and net capital outflow. Have students get out a piece of paper, draw this graph on it, and then do the analysis. A couple minutes should suffice. It might be useful to have them compare their answers with the results from the closed economy case.

20 3. 투자수요의 증가 r S, I S I (r )2 I (r )1 I 1 I 2 ANSWERS: I > 0,
NX2 ANSWERS: I > 0, S = 0, net capital outflows and net exports fall by the amount I I (r )1 I 1 NX1 I 2 In contrast to a closed economy, investment is not constrained by the fixed (domestic) supply of loanable funds. Hence, the increase in firm’s demand for loanable funds can be satisfied by borrowing abroad, which reduces net outflows of financial capital. And since net capital outflows = NX, we see a fall in NX equal to the increase in investment.

21 명목 환율 e = nominal exchange rate, 양국 통화의 상대가격. (e.g. Yen per Dollar)
Warning to students: Some textbooks and newspapers define the exchange rate as the reciprocal of the one here (e.g., dollars per yen instead of yen per dollar). The one here is easier to use, because a rise in “e” corresponds to an “appreciation” of the country’s currency. Using the reciprocal would mean that a rise in “e” is a depreciation, which seems counter-intuitive. So it would be worthwhile to point out to students that a country’s “e” is simply the price (measured in foreign currency) of a unit of that country’s currency.

22 환율 (July 12, 2004) country exchange rate Euro 0.81 Euro/$ Japan
108.2 Yen/$ Mexico 11.5 Pesos/$ Russia 29.1 Rubles/$ South Africa 6.0 Rand/$ Turkey 1,437,120 Liras/$ U.K. 0.54 Pounds/$ If you’d like to update these figures before your lecture, you can find good exchange rate data at:

23 실질환율 = real exchange rate, 양국 물품의 교환비율 ε
(e.g. Japanese Big Macs per U.S. Big Mac) ε epsilon

24 실질환율 ε ε 실질환율 = 명목환율 x 국내상품가격/외국상품가격 실질환율 = 명목환율 x 물가수준비율(P/P*)
Students often have trouble understanding the units of the real exchange rate. It’s worth explaining each line carefully, and making sure students understand it before displaying the next line. Note: The examples here and in the text are in terms of one good, i.e. Big Macs. But P and P* are the overall price levels of the domestic & foreign countries. Thus, they each measure the price of a basket of goods. When you get to the bottom line, emphasize that the real exchange rate measures the amount of purchasing power in Japan that must be sacrificed for each unit of purchasing power in the U.S.

25 How NX depends on ε ε  실질환율이 높아지면 외국물품의 상대가격이 낮아지고 국내물품의 가격이 높아진다. 따라서,  EX, IM  NX

26 ~ McZample ~ ε one good: Big Mac price in Japan: P* = 200 Yen
price in USA: P = $2.50 nominal exchange rate e = 120 Yen/$ 미국에서 빅맥을 사는 일본인은 일본보다 1.5배의 가격을 지불해야 한다. ε

27 순수출 함수 따라서 net exports function 는 순수출(NX) 과 ε의 부의 관계를 나타내고 있다: NX = NX (ε )

28 The NX curve ε So, 순수출 규모가 크다 ε 상대적으로 낮으면 국내 물품의 가격이 저렴하다 ε1 NX(ε) NX
NX ε NX(ε) NX(ε1) So, 순수출 규모가 크다 ε1 ε 상대적으로 낮으면 국내 물품의 가격이 저렴하다

29 The NX curve 상대가격이 상당히 상승하면 수출하는 것 보다 수입하므로 ε ε2 무역적자 발생 NX(ε) NX
상대가격이 상당히 상승하면 수출하는 것 보다 수입하므로 NX ε NX(ε) NX(ε2) 무역적자 발생

30 그러면, ε 실질환율은 어떻게 결정되나? 국민소득계정 항등식은 NX = S - I
We saw earlier how S - I is determined: S 은 국내변수에 의해 결정된다. (output, fiscal policy variables, etc) I 은 세계이자율에 의해서 결정된다. r * So, ε 는 항등식 계정을 유지하기 위해 조정된다 In the equation, ε is the only endogenous variable, hence this equation determines its value.

31 How ε is determined S 와 I 는 ε, 함수가 아니다. ε 1
NX NX(ε ) ε 1 실질이자율이 NX와 S - I의 항등식을 일치시킨다 *** Note *** At the lower left corner of this graph, NX does NOT NECESSARILY EQUAL ZERO!!! NX 1

32 supply: 해외 투자를 위한 외환유출(S - I )
외환시장의 균형 demand: 외국인의 순수출에 대한 자국통화의 수요 ε NX NX(ε ) supply: 해외 투자를 위한 외환유출(S - I ) ε 1 WARNING: Don’t let your students confuse the demand for dollars in the foreign exchange market with demand for real money balances (chapter 4), or the supply of dollars in the foreign exchange market with the supply of money (chapter 4). If you and your students are into details: NX is actually the net demand for dollars: foreign demand for dollars to purchase our exports minus our supply of dollars to purchase imports. Net capital outflow is the net supply of dollars: The supply of dollars from U.S. residents investing abroad minus the demand for dollars from foreigners buying U.S. assets. NX 1

33 Four experiments 1. 국내재정 정책 2. 해외재정 정책 3. 투자 수요 증가 4. 무역보호 정책

34 1. 국내재정정책 재정지출의 확대는 reduces national saving, net capital outflows, and the supply of dollars in the foreign exchange market… NX 2 ε 2 ε NX NX(ε ) ε 1 NX 1 …환율 상승으로 순수출 감소 NX to fall.

35 2. 해외 재정정책 An increase in r* reduces investment, increasing net capital outflows and the supply of dollars in the foreign exchange market… ε NX NX(ε ) NX 1 ε 1 ε 2 NX 2 …causing the real exchange rate to fall and NX to rise.

36 3. 국내투자수요의 증가 An increase in investment reduces net capital outflows and the supply of dollars in the foreign exchange market… NX 2 ε 2 ε NX NX 1 NX(ε ) ε 1 Suggestion: Have your students do this experiment as an in-class exercise. Have them take out a piece of paper, draw the graph, then show what happens when there’s an increase in the country’s investment demand (perhaps in response to an investment tax credit). …causing the real exchange rate to rise and NX to fall.

37 4. 수입억제를 위한 보호무역정책 ε 2 ε 1 NX (ε )2 NX (ε )1
4. 수입억제를 위한 보호무역정책 At any given value of ε, an import quota  IM  NX  자국통화수용증가 ε NX NX (ε )1 NX1 ε 1 NX (ε )2 ε 2 보호무역정책은 S or I , so capital flows and the supply of dollars 변화를 가져오지 않는다 The analysis here applies for import restrictions (tariffs, quotas) as well as export subsidies.

38 4. Trade policy to restrict imports
Results: ε > 0 (demand increase) NX = 0 (supply fixed) IM < 0 (policy) EX < 0 (rise in ε ) ε NX NX1 NX (ε )2 NX (ε )1 ε 2 ε 1 In the text box, the remarks in parentheses after each result is an abbreviated explanation for that result. The real exchange rate appreciates because the quota has raised the net demand for dollars associated with any given value of the exchange rate. But the equilibrium level of net exports doesn’t change, because the supply of dollars in the foreign exchange market (S-I) has not been affected by the trade policy. (Remember, S = Y-C-G, and the trade policy does not affect Y, C, or G; the policy also does not affect I, because I = I(r*) and r* is exogenous.) The appreciation causes exports to fall. And, since exports are lower but NX is unchanged, it must be the case that IM is lower too, which is what you’d expect from a trade policy that restricts imports.

39 명목환율의 결정 실질환율: 명목환율:

40 명목환율의 결정 명목환율은 실질환율 , 상대가격에 의해 결정된다… …그리고 그 각자는 :
…그리고 그 각자는 : It’s important here for students to learn the (logical, not necessarily chronological) order in which the variables are determined. I.e., what causes what.

41 명목환율의 결정요인 변화율로 표시하면 Here we again see the Classical Dichotomy in action. The real exchange rate is determined by real factors, and nominal variables only affect nominal variables. 주어진 실질환율 ε에서, 명목환율의 변화율 e은 외국과 자국의 물가상승률의 차이에 달려있다.

42 Inflation differential
Percentage 10 change 9 in nominal exchange 8 South Africa rate 7 6 Depreciation relative to 5 Italy U.S. dollar 4 New Zealand Australia Spain 3 Sweden Ireland 2 Canada 1 UK France Belgium Figure 5-13 on p The horizontal axis measures the country’s inflation rate minus the U.S. inflation rate. The vertical axis measures the percentage change in the U.S. dollar exchange rate with that country. This figure shows a very clear relationship between the inflation differential and the rate of dollar appreciation. - 1 Appreciation Germany Netherlands 2 - relative to Switzerland U.S. dollar - 3 Japan - 4 - 3 - 2 - 1 1 2 3 4 5 6 7 8 Inflation differential

43 The U.S. as a large open economy
So far, we’ve learned long-run models for two extreme cases: 폐쇄경제 (chapter 3) 작은 개방경제(chapter 5) A large open economy (거대 개방경제) --- like the U.S. --- 는 두 극단적인 모형의 중간이다. For example…

44 재정정책의 효과 개방의 정도에 달려 있다: NX I r large open economy small open economy
closed economy rises rises, but not as much as in closed economy no change falls falls, but not as much as in closed economy no change In the table, there’s a cell for NX in the closed economy column. Instead of putting “N.A.” in this cell, I put “no change.” Why? In a closed economy, EX = IM = NX = 0. After a change in saving, NX = 0 still. Hence, it is not incorrect to say “no change”. More importantly we are trying to show students how the results for a large open economy are in between the results for the closed & small open cases. Looking at the items in the last row of the table, “falls, but not as much as in small open economy” seems to be in between “no change” and “falls,” but does not seem to be in between “N.A.” and “falls”. It would be completely understandable if you still feel that “N.A.” should be in the closed economy NX cell of the table, so please feel free to edit that cell. no change falls, but not as much as in small open economy falls

45 Chapter summary exports and imports
1. Net exports--the difference between exports and imports a country’s output (Y ) and its spending (C + I + G) 2. Net capital outflow equals purchases of foreign assets minus foreign purchases of the country’s assets the difference between saving and investment 3. National income accounts identities: Y = C + I + G + NX trade balance NX = S - I net capital outflow

46 Chapter summary NX increases if policy causes S to rise or I to fall
4. Impact of policies on NX : NX increases if policy causes S to rise or I to fall NX does not change if policy affects neither S nor I. Example: trade policy 5. Exchange rates nominal: the price of a country’s currency in terms of another country’s currency real: the price of a country’s goods in terms of another country’s goods. The real exchange rate equals the nominal rate times the ratio of prices of the two countries.

47 Chapter summary 6. How the real exchange rate is determined NX depends negatively on the real exchange rate, other things equal The real exchange rate adjusts to equate NX with net capital outflow 7. How the nominal exchange rate is determined e equals the real exchange rate times the country’s price level relative to the foreign price level. For a given value of the real exchange rate, the percentage change in the nominal exchange rate equals the difference between the foreign & domestic inflation rates.

48