Lecture 7: Open EconomyOpening the Economy• Goods markets – Imports and exports – Tariffs and quotas• Financial markets– Domestic and foreign financial assets– Capital controls – Emerging market crises• Factor markets– Migration of firms and workersBasics: Goods Markets• Trends and U.S. trade deficit - Figure 18.1• New decision: – whether to buy domestic or foreign goods• Key ingredient: The Real Exchange Rate– The nominal exchange rate– Price levelsThe Nominal Exchange Rate• The price of foreign currency in terms of domestic currency– Chile E = 610 (pesos/dollar)– Japan E = 110 (yens/dollar)– Euro E = 0.82 (euros/dollar)• To convert pesos prices into dollar prices; divide peso price by E• Appreciation and depreciation (trend and cycle) -- Figure 18-6The Real Exchange Rate• The price of a foreign good in terms of domestic good e = E P*PReal appreciation and depreciationFinancial Markets• Diversification and speculation•Very large• Trade deficits and surpluses become possibleThe Balance of PaymentCURRENT ACCOUNTExports +Imports -Trade Balance Net investment income and transfers +Current Account BalanceCAPITAL ACCOUNTIncrease in foreign holding of domestic assets +Increase in domestic holding of foreign assets -Errors and omissions / statistical discrepancy Capital Account BalanceForeign or Domestic Assets•Risk, etc• Here: Compare returns• (Uncovered) interest parity condition:1+ i(t) versus (1/E(t)) (1+i*(t)) E(t+1)eFigure 18-9The Goods Market Z = C + I + G + X - e QC(Y-T) + I(Y,I) + GQ = Q(Y,e)+ -X = X(Y*,e)+ +Figures• Figs 19.1 and 19-2• Increase in domestic and foreign demand• games countries play•
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