Introduction To Macroeconomics

I.
1 THE ISLM MODEL IN

AN OPEN ECONOMY
a) Openness in goods market
b) Openness in financial market
c) Goods and financial markets in an open economy
Ch. 6 in Blanchard-Amighini-Giavazzi
Blanchard, Amighini and Giavazzi, Macroeconomics: A European Perspective PowerPoints on the Web, 2nd edition Pearson Education Limited 2014
The ISLM Model in an Open Economy

Slide
6.2
Openness has three distinct dimensions:

1.
Openness in goods markets. Free trade restrictions

include tariffs and quotas.
2.
Openness in financial markets. Capital controls place

restrictions on the ownership of foreign assets.
3.
Openness in factor markets. The ability of firms to choose

where to locate production, and workers to choose where to
work.
a) Openness in Goods Markets

Slide
6.3
A good index of openness is the proportion of aggregate output

composed of tradable .
Table 6.1 Ratios of exports to GDP (%) for selected OECD countries, 2010
(Source: Eurostatt)
The main factors behind differences in export ratios are geography

and size:
Distance from other markets.
Size also matters: The smaller the country, the more it must
specialise.
Exchange Rates
Slide
6.4
When goods markets are open, domestic consumers

must decide whether to buy domestic or foreign goods.
Central to the decision is the price of domestic goods
relative to foreign goods (the real exchange rate).
The nominal exchange rate is the price of the domestic
currency in terms of the foreign currency.
The real exchange rate is the price of domestic goods
in terms of foreign goods.
Multilateral exchange rates are exchange rates
between several countries.
Nominal Exchange Rate

Slide
6.5
Under flexible nominal exchange rates:
An appreciation is an increase in the exchange rate (an increase in the

price of the domestic currency in terms of the foreign currency).
A depreciation is a decrease in the exchange rate (a decrease in the

price of the domestic currency in terms of the foreign currency).
Under fixed nominal exchange rates:
Revaluations, rather than appreciations, which are increases in the

exchange rate.
Devaluations, rather than depreciations, which are decreases in the

exchange rate.
Nominal exchange rate between

the British pound and the euro
Slide
6.6
Trend: depreciation of
the pound vis--vis the
euro over the period.
Large fluctuations: there

was a very large
appreciation of the
pound at the end of the
1990s, followed by a
large depreciation in the
following decade.
Figure 6.2 The nominal exchange rate between the British

pound and the euro since 1999 (Source: European Central Bank).
Real Exchange Rate

Slide
6.7
From nominal to real exchange rates between Germany and

the UK:
If the price of a Mercedes in Germany is 50,000 and a euro is

worth 1.15 pounds, then the price of a Mercedes in pounds is
50,000 X 1.15 = 43,000.
If the price of a Jaguar in the UK is 30,000, then the price of a

Mercedes in terms of Jaguars would be 43,000/30,000 = 1.4.
To generalize this example to all of the goods in the economy,

we use a price index for the economy, or the GDP deflator:
EP
=
P
*
Slide
6.8
EP
=
P
*
1. P = price of UK goods in pounds.

2. P* = price of European goods in
euros.
3. E = nominal exchange rate.
Slide
6.9
The nominal and the real exchange

rates in the UK have moved largely
together since 1999:
Figure 6.4 Real and nominal exchange rates in the UK since 1999
Source: ECB, Eurostat, Bank of England.
The large nominal and real

appreciation of the pound at the
end of the 1990s and the
collapse in 20082009.
The large fluctuations in the

nominal exchange rate also
show up in the real exchange
rate.
This reflects the fact that, since

then, inflation rates have been
very similar and lowin both
areas.
Multilateral Exchange Rate

Slide
6.10
Bilateral exchange rates are exchange rates between

two countries.
Multilateral exchange rates are exchange rates
between several countries.
For example, to measure the average price of UK goods
relative to the average price of goods of UK trading
partners, we use the UK share of import and export trade
with each country as the weight for that country.
Equivalent names: real multilateral UK exchange rate;
UK trade-weighted real exchange rate; UK effective real
exchange rate.
Slide
6.11
The 1980s and 1990s were

characterised by large
swings in the real exchange
rate.
The real exchange rate was
much more stable since the
end of the 1990s, until the
large real depreciation in
2009.
Figure 6.5 The UK multilateral real exchange rate since 1980

Source: Bank of England.
b) Openness in Financial Markets

Slide
6.12
The purchase and sale of foreign assets implies

buying or selling foreign currencysometimes called
foreign exchange.
Openness in financial markets implies:
Financial investors can diversifyto hold both domestic
and foreign assets and speculate on foreign interest rate
movements.
Countries may run trade surpluses and deficits. A country
that buys more than it sells must pay for the difference by
borrowing from the rest of the world.
The Balance of Payments

Slide
6.13
The balance of payments account summarises a

countrys transactions with the rest of the world.
It is composed by the current account and the capital
account.
The current account balance and the capital account
balance should be equal, but because of data
gathering errors they arent (statistical discrepancy).
The Current Account

Slide
6.14
It records the following payments to and from the rest

of the world:
Exports minus imports of goods and services (balance of
trade).
Earnings on foreign investments minus payments made to
foreign investors (net primary income or factor income).
Net remittances, donations, aids, or official assistance (net
cash transfers).
The sum of net payments in the current account balance can
be positive, in which case the country has a current account
surplus, or negativea current account deficit.
The Capital Account

Slide
6.15
The capital account balance, also known as net

capital flows, can be positive or negative:
If foreign holdings of domestic assets are greater than
domestic holdings of foreign assets, there is a capital
account surplus.
Negative net capital flows are called a capital account
deficit.
The numbers for current and capital account

transactions are constructed using different sources;
although they should give the same answers, they
typically do not. The difference between the two is
called the statistical discrepancy.
GDP versus GNP: The Example

of Ireland
Slide
6.16
Gross domestic product (GDP) is the measure that corresponds

to value added products, domestically.
Gross national product (GNP) corresponds to the value added
products by domestically owned factors of production.
Table 6.4
GDP, GNP and net factor income in Ireland, 20022008

Source: Central Statistics Office Ireland.
The uncovered interest parity relation

Slide
6.17
Choice between domestic and foreign assets:

The decision or whether to invest abroad or at home depends not only
on interest rate differences but also on your expectation of what will
happen to the nominal exchange rate.
Figure 6.6 Expected returns from holding one-year UK bonds or one-year US bonds
Slide
6.18
If both UK bonds and US bonds are to be held, they

must have the same expected rate of return, so that
the following arbitrage relation must hold:
1
(1 + i ) = ( E )(1 + i )
E
*
t +1
Rearranging the equation, we obtain the uncovered

interest parity relation, or interest parity condition:
E
(1 + i ) = (1 + i )
E
*
t +1
Slide
6.19
The uncovered interest parity relation can also be written as:
(1 + i )
(1 + i ) =
[1 + ( E E ) / E )]
*
t +1
A good approximation of the equation above is given by:

e
E
E
i i
*
t +1
That is, arbitrage implies that the domestic interest rate must
be (approximately) equal to the foreign interest rate plus the
expected depreciation rate of the domestic currency.
If
e
t +1
= E , then i =
t
*
t
Slide
6.20
A higher domestic interest rate

leads to a higher exchange rate
an appreciation.
Figure 6.10 The relation between the interest

rate and exchange rate implied by interest parity
Slide
6.21
The assumption that financial investors will hold only the bonds with
the highest expected rate of return is obviously too strong, for two
reasons:
It ignores transaction costs.
It ignores risk.
Investors care not only about returns but also about risk and about
liquidity. Perceptions of risk often play an important role in the
decisions of large financial investors.
Sudden stop: when perceived risk is too high and the investors sell
all the assets they have in that country.
Examples: Latin America in the 1980s, appreciation of the dollar in
1990s.
Slide
6.22
UK and US nominal
interest rates have
largely moved
together over the
past 40 years.
Figure 6.7 Three-months nominal interest rates in the USA and in the UK
since 1970
c) Goods and Financial Markets in

an Open Economy
Slide
6.23
The IS Relation in an Open Economy

Slide
6.24
Putting Goods and Financial Market

Together in an Open Economy
Slide
6.25
Figure 6.11 The ISLM model in an open economy
An increase in the interest rate reduces output both directly and

indirectly (through the exchange rate): the IS curve is downward
sloping. Given the real money stock, an increase in output increases the
interest rate: the LM curve is upward sloping.

Introduction To Macroeconomics

Загружено:

Сведения о документе

Оригинальное название

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Introduction To Macroeconomics

Загружено:

Авторское право:

Доступные форматы

I.

1 THE ISLM MODEL IN

The ISLM Model in an Open Economy

Openness has three distinct dimensions:

Openness in goods markets. Free trade restrictions

Openness in financial markets. Capital controls place

Openness in factor markets. The ability of firms to choose

a) Openness in Goods Markets

A good index of openness is the proportion of aggregate output

The main factors behind differences in export ratios are geography

When goods markets are open, domestic consumers

Nominal Exchange Rate

Under flexible nominal exchange rates:

An appreciation is an increase in the exchange rate (an increase in the

A depreciation is a decrease in the exchange rate (a decrease in the

Under fixed nominal exchange rates:

Revaluations, rather than appreciations, which are increases in the

Devaluations, rather than depreciations, which are decreases in the

Nominal exchange rate between

Large fluctuations: there

Figure 6.2 The nominal exchange rate between the British

Real Exchange Rate

From nominal to real exchange rates between Germany and

If the price of a Mercedes in Germany is 50,000 and a euro is

If the price of a Jaguar in the UK is 30,000, then the price of a

To generalize this example to all of the goods in the economy,

1. P = price of UK goods in pounds.

The nominal and the real exchange

The large nominal and real

The large fluctuations in the

This reflects the fact that, since

Multilateral Exchange Rate

Bilateral exchange rates are exchange rates between

The 1980s and 1990s were

Figure 6.5 The UK multilateral real exchange rate since 1980

b) Openness in Financial Markets

The purchase and sale of foreign assets implies

The Balance of Payments

The balance of payments account summarises a

The Current Account

It records the following payments to and from the rest

The Capital Account

The capital account balance, also known as net

The numbers for current and capital account

GDP versus GNP: The Example

Gross domestic product (GDP) is the measure that corresponds

GDP, GNP and net factor income in Ireland, 20022008

The uncovered interest parity relation

Choice between domestic and foreign assets:

If both UK bonds and US bonds are to be held, they

Rearranging the equation, we obtain the uncovered

The uncovered interest parity relation can also be written as:

A good approximation of the equation above is given by:

A higher domestic interest rate

Figure 6.10 The relation between the interest

c) Goods and Financial Markets in

The IS Relation in an Open Economy

Putting Goods and Financial Market

Figure 6.11 The ISLM model in an open economy

An increase in the interest rate reduces output both directly and

Вам также может понравиться