Lecture 7: Open EconomyOpening the EconomyBasics: Goods MarketsThe Nominal Exchange RateThe Real Exchange RateFinancial MarketsThe Balance of PaymentForeign or Domestic AssetsThe Goods MarketFiguresLecture 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 Payment CURRENT ACCOUNT Exports + Imports - Trade Balance Net investment income and transfers + Current Account Balance CAPITAL 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
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