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48:17
Transcript
0:16
so now we're going to go back to to the
0:18
first part of the course in the sense
0:20
that um
0:23
um that we're going to go back to sort
0:25
of the the short term okay so so we're
0:28
going to essentially do the eslm mode
0:30
again but now in the context of an open
0:33
economy but before I get into that first
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0:35
model of this part of the course I want
0:37
to
0:39
um finish the previous
0:41
lecture in which I was introducing the
0:44
concept of openness and the key relative
0:46
prices H in open economy and we stopped
0:50
after discussing this and says well one
0:52
of the things that that open an economy
0:55
means is that now you can buy Goods both
0:58
at home or abroad so you need to be able
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1:00
to compare these two different kind of
1:02
goods and controlling for quality and
1:04
all these differences and all that at
1:07
the end of the day you want some sense
1:08
of relative prices which good is more
1:11
expensive than the other one and we said
1:13
for that we use what is called the real
1:16
exchange rate okay and we Define the
1:18
real exchange rate as well essentially a
1:21
it's the relative prices of of goods at
1:24
home versus abroad H but we had to put
1:28
them in a common currency that's the
1:29
reason we we couldn't just directly
1:30
compare the prices at home versus the
1:32
prices abroad we had to convert the
1:35
prices at home to the unit of account of
1:37
the other country and then we could
1:40
compare these two things and that's what
1:41
we call the real exchange rate when that
1:43
thing goes up we call that's a real
1:46
appreciation of of of the local currency
1:49
of the local economy and and that means
1:52
that the goods domestic Goods become
1:54
more expensive relative to International
1:57
Goods when when the that Epsilon goes
2:00
down then we call we say the real
2:02
exchange has depreciated and that means
2:04
that their domestic Goods become cheaper
2:06
relative to foreign Goods okay so as a
2:09
key Concept in the in what it means when
2:11
you open an economy you need to have a
2:13
this price is very important to decide
2:16
whether you're going to again whether
2:18
you and foreigners are going to buy
2:20
Goods abroad or domestically the second
2:23
concept of openness that we're going to
2:25
explore in this course is openness in
2:28
capital account in financial Market
2:29
Market an openness in financial Market
2:31
means something very similar which is
2:34
now you when you have a dollar to invest
2:37
financially invest not physical
2:38
investment not real investment well you
2:41
can decide whether to invest in domestic
2:43
assets or foreign assets we're going to
2:45
in this and later on we're going to talk
2:47
about Equity but for now bonds so
2:50
suppose you have a domestic Bond and a
2:52
foreign bond well you can decide whether
2:55
to invest in the domestic Bond or in the
2:56
foreign bond okay now to make that
2:59
compar
3:00
Aron is not enough to have the current
3:03
exchange rate because it doesn't mean
3:06
much if I tell you that the British bond
3:08
is more expensive than a domestic a
3:11
dollar
3:12
Bond H what you really need in order to
3:15
decide where to invest is some sense
3:18
what is the expected relative return of
3:20
these two things do I expect to make
3:22
more money in the dollar Bond or in the
3:25
in the uh pound Bond and and I that's a
3:30
comparison I need to be able to make
3:32
okay there are also risk considerations
3:35
and so on that we're going to not going
3:36
to discuss in this in this course but
3:38
the but the very basic comparison is not
3:42
the value of things when you're talking
3:44
about financial but what is a return you
3:46
expect to get in one or the other okay
3:48
so this is what you need to do suppose
3:51
you have a dollar of invest dollar to
3:53
invest and you have two options one is
3:56
you buy a dollar Bond the dollar Bond
3:58
gives you an interest rate of it so you
4:00
know that say 5% nowadays more or less
4:05
that if you have a dollar today and you
4:06
invest it in a in a dollar Bond you're
4:08
going to get Next Period you're going to
4:11
get a h how much is it $100 supposed you
4:15
have $1 then you're going to get a a
4:18
five cents on that dollar at the end of
4:21
the year okay and so that's what you get
4:26
if you invest in the dollar Bond now
4:28
you're given now an option because
4:29
because we are open to financial markets
4:32
to also invest in a British bond in a
4:34
pound bond that is as safe as the US
4:37
Bond say and uh so we're going to call
4:40
that the UK Bond and I know for example
4:43
that the UK bond is offering a 10%
4:46
interest rate okay so suppose that I
4:49
that I think IST star is
4:51
10% then I ask you the question well
4:54
does that mean that obviously since you
4:56
want to compare returns that you should
4:58
be investing in the
5:00
in the pound bond in the UK Bond rather
5:02
than the US Bond so suppose this is 5%
5:05
and that's 10% and now tell you where do
5:08
you want to invest your money do you
5:09
want to invest it in the US Bond or in
5:12
the UK
5:13
Bond what is your
5:17
answer sounds obvious no they pay you
5:19
10% the other one pays you 5%
5:30
exactly why do I need to know
5:34
that exact so this this is not enough
5:38
information for me because it may happen
5:40
that what I get in terms of return I
5:42
lose on the currency currency
5:44
exposure for example so so let's see how
5:48
that can happen so how would I do this I
5:50
have $1 of wealth that I want to invest
5:53
and suppose I want to go the UK Bond
5:55
route so the first thing I have to do is
5:58
I have to convert the dollar into pounds
5:59
today to buy my dollar which my UK bond
6:03
which will be in pounds so I first thing
6:05
I have to use you know suppose I get
6:09
8 pounds per dollar then then I I can
6:13
invest .8 pounds in in in h in UK bonds
6:18
with my
6:19
dollar H that will give me8 * 1 plus 1
6:24
point one 1 plus is star tomorrow but
6:29
what are the units of this what do I get
6:32
there next year what do I get next year
6:35
I invested
6:37
8 ER pounds and I got8 time 1.1 say
6:44
pounds but I just told you so what I get
6:47
next year is pounds I cannot compare a
6:50
return in dollars which this was $
6:53
1.05 with a return on pounds I need to
6:55
be able to convert those pounds pounds
6:57
in the future to in the future and the
7:01
best I can do here we're not going to
7:02
open forward markets or anything is well
7:06
I can that means I have to divide by the
7:08
exchange rate next year to convert from
7:10
pounds to dollars I don't know the
7:12
exchange rate of next year so the best I
7:14
can do is use expected exchange rate
7:17
okay so so I divide this by the expected
7:20
exchange rate next year and then I get
7:24
that's my return in dollars of having
7:26
gone the UK B route okay and so what I
7:30
need to compare in order to decide where
7:33
do I want to put my money is that return
7:36
here versus that one there that's in the
7:39
same units of account is I invest the
7:41
same today $1 and I get dollars tomorrow
7:45
so now I can
7:48
compare and as you correctly pointed out
7:51
this this this uh this thing here
7:53
therefore requires that you you sort of
7:56
think about what the exchange rate is
7:58
likely to be tomorrow so for example in
8:00
my example here when I said suppose I is
8:03
5% and I star interest rate in UK bone
8:07
is 10% is it obvious that they should
8:09
invest in the in the UK Bond and the
8:12
answer is no not so fast because I know
8:14
I'm going to make 5% more in terms of
8:16
the return of the bond but then when I
8:18
convert it back to Dollar I may lose all
8:19
that gain because the the the the pound
8:22
has depreciated visis the dollar in
8:25
particular if the pound I expect the
8:27
pound to depreciate Rel to or if I
8:30
expect the dollar to appreciate relative
8:32
to the pound by 5% then I'm
8:35
indifferent yeah in one case I get
8:38
because if I go the the US Bond route I
8:40
get five 5% next year from this year to
8:44
next if I go the UK bone route I get 10%
8:48
in return in the bond minus 5% in the
8:50
capital loss due to the the the
8:53
appreciation of the dollar so on net I
8:55
get 5% as well that's what appears here
8:58
that's what I've done here here so what
9:00
I did here is say you know if the
9:02
markets are very integrated and they
9:03
function fairly well those two returns
9:06
should be more or less similar in
9:08
equilibrium because prices are going to
9:10
adjust exchanges are going to adjust and
9:12
so on so these two ways of investing are
9:15
more or less the same I'm going to take
9:17
the stream assumption that they are
9:18
exactly the same
9:20
here so that this holds that the
9:23
equilibrium we have to find that
9:24
equilibrium these two things are going
9:26
to be equal that's called and it's a
9:29
very important Concept in international
9:30
finance the uncover inp parity condition
9:34
don't ask me why it's uncover but it's
9:36
it's the inp parity condition and and
9:39
again that one in particular is called
9:41
the uncover interp condition if you do a
9:45
little bit of and this just tells you
9:47
that in equilibrium you have to be more
9:49
be indifferent between investing to in
9:52
one bone or the other okay if you do a
9:55
little algebra here of the kind of we
9:57
have done in the past like you know 1
9:58
plus I is I is approximately equal to
10:04
one is approximately equal to 1 over 1
10:07
minus I or or this one 1 plus I star is
10:11
approximately equal to one over 1 minus
10:14
I star and so on that's that kind of
10:15
approximation tailor expansion when when
10:19
these terms are small then you can write
10:22
this as this expression
10:24
here okay and this says exactly what I
10:27
just said in words this says
10:30
look if the interest rate in the US bond
10:34
is lower than
10:36
the than the UK bonds interest rate
10:42
that's okay in the sense that we can be
10:44
different between these two things as
10:45
long as you're expecting a depre an
10:48
appreciation of the
10:49
dollar that is equivalent to the
10:52
difference in this two interest rate
10:54
okay so that's what's called the
10:56
interest parity condition the two in
10:59
equilibrium the two are going to be the
11:01
same once you adjust for the expected
11:03
appreciation or depreciation of the
11:05
currency okay so in my example before we
11:09
had this interest rate with 5% that was
11:13
10% then the only way that will that's
11:15
going to be an equilibrium is that if we
11:17
also expect the dollar to appreciate by
11:21
5% okay so dollar appreciation remember
11:24
is this guy going up so if this is 5%
11:28
then it's fine to have 5% here 10% there
11:32
because they both gave me the same
11:33
return in expectation at least okay if I
11:36
do it in dollars I say I'm going to get
11:38
5% either way invest in direct in
11:41
dollars or through the UK pound because
11:44
in the in the UK bone in the UK bone I'm
11:46
going to get 10% and then lose 5%
11:48
because of the of the currency or I can
11:51
do the comparison in pounds and and then
11:53
I say well I'm going to get 10% in
11:55
pounds directly and if I go the US way
11:58
I'm going to get 5% but I'm going to get
12:00
also 5% in the currency appreciation and
12:02
that gives me 10% okay key concept
12:06
anyways so these are the two senses of
12:08
opening that we can have opening in in
12:11
Goods Market opening in financial
12:13
markets and the the the key relative
12:16
prices and and things are going to
12:19
equilibrate both markets one is the real
12:23
exchange rate in the Goods Market in
12:25
this one is the uncovering transparity
12:28
condition I want to shut down this part
12:30
of openness H for a lecture or so and
12:33
I'm going to focus now on the on the
12:35
Goods Market open opening only okay and
12:38
then I'm going to come back to this but
12:40
I just wanted to show you the two senses
12:43
of opening okay so now let's forget a
12:46
little bit about financial opening and
12:49
and uh and let's just focus on opening
12:53
the goods markets to International Trade
12:55
okay so that means we're going to have
12:57
now imports and exports floating around
12:59
so this is we go back again to our aslm
13:02
mod H to actually want to go back to our
13:05
Goods Market only mod the very first
13:07
model we saw in this course but we're
13:09
going to bring back a couple of terms
13:11
that we shut down there okay now
13:16
something that will be that we didn't
13:17
need to worry about but we're going to
13:19
have to worry about here a lot is that
13:22
there is a distinction between the
13:23
demand for domestic goods and the
13:26
domestic demand for goods
13:29
okay I know this going to be tricky but
13:31
but okay there's a difference between
13:33
demand for domestic Goods versus the
13:36
domestic demand for goods this is what
13:39
residents us say us residents household
13:42
firms government demand in terms of
13:46
goods this is how those same agents plus
13:49
the rest of the world demand of
13:51
domestically produced Goods that's the
13:54
distinction when the economy was closed
13:56
they were the same but now they're not
13:59
okay so the domestic demand Remains the
14:03
Same as before okay domestic demand is
14:06
whatever the households demand
14:08
consumption plus firm's investment plus
14:12
government expenditure that's the same
14:14
we had in close economy this hasn't
14:18
changed the domestic demand is the same
14:19
is a function of the same behavioral
14:21
functions that we had there and the only
14:24
behavioral function that was in the only
14:26
two that we had was the consumption
14:28
function and investment function
14:29
remember so That Remains the Same
14:30
nothing has changed what does change is
14:33
that this is no longer what determines
14:36
the demand for domestically produced
14:38
goods and remember that's very key in
14:40
the short run because this is so Canan
14:43
model with very sticky prices demand
14:45
determines output activity so if we're
14:48
going to determine domestic production
14:50
from demand we better be very careful
14:52
about what is the demand for
14:54
domestically produced Goods this is
14:57
demand for both domestically produced
14:58
good and foreign produced Goods some of
15:00
those demand will be satisfied by
15:02
Imports that's not demand for domestic
15:04
production and therefore will not be
15:06
determined equilibrium output
15:08
domestically okay so this is going to be
15:11
the New Concept which is demand for
15:13
domestic goods and demand for domestic
15:16
Goods is the same as demand as domestic
15:19
demand for goods that the thing we had
15:21
in close economy minus that part of
15:24
demand that is Satisfied by Imports so
15:26
minus Imports and divided by The
15:28
Exchange because inputs may be priced in
15:30
euros say and I have to convert them
15:32
into dollars that's the reason very
15:33
exchange don't worry about this for now
15:36
okay so I had to subtract from that
15:40
Imports because that's Demand by
15:44
Resident us resident that doesn't go to
15:47
demand to demand for domestically
15:50
produced Goods it's demand for BMWs
15:52
whatever so that's not going to affect
15:54
the demand for Ford good cars and
15:57
therefore it will not affect the
15:58
production of four
16:00
cars because it's not demand for that
16:04
but against that we also have the demand
16:07
a component of demand for domestically
16:09
produced good that we didn't have before
16:11
which is what foreigners demand from the
16:14
US okay part of the demand that probably
16:18
not for a lot at least part of the the
16:21
demand that us
16:24
Goods perceived us production perceived
16:27
is not due to resident is due to
16:30
foreigners that are importing us Goods
16:33
okay Apple s sells a lot of phones to
16:36
the rest of the
16:37
world okay that's determined by Foreign
16:40
demand for domestically produced good
16:42
that's what we want to call X exports
16:46
okay so this is our new key concept here
16:50
Z okay which is the same as what we used
16:53
to have but now we need to understand
16:55
two more terms the export and it ask
16:58
going to be a function and import which
17:02
also will be a function so let me
17:04
introduce that so exports we're going to
17:07
assume simplify things but it's sensible
17:11
behavioral assumption we're going to
17:13
assume that exports are increasing in
17:15
foreign output that's what y star
17:18
means and it makes sense is the rest of
17:22
the world I mean Emerging Market the
17:24
commodity producing economies today are
17:27
very excited about the recover in China
17:30
no China is reopening so so it's a big
17:33
boom domestically that's great news for
17:36
the Emerging Markets commodity producers
17:37
because that will increase the demand
17:40
from China for goods produced around the
17:42
world in particular in commodity
17:44
producing economies so so that's what
17:47
this is capturing if if an important
17:49
trading partners output goes up income
17:51
goes up then they're they're going to
17:53
consume everything they're domestic
17:55
Goods but they're also going to consume
17:56
the goods they import which are our
17:59
exports okay so that's the reason this
18:01
is
18:02
increasing ER exports are decreasing on
18:06
the real exchange
18:08
rate that's sensible assumption why why
18:10
do you think it's a sensible assumption
18:12
so why do you think that exports US
18:15
exports are decreasing on the real
18:19
exchange rate
18:26
Epsilon for for foreign customers to BU
18:30
exactly because then us Goods become
18:32
more expensive relative to foreign Goods
18:34
that's what a real exchange appreciation
18:36
is and therefore there is L less demand
18:39
for domestically for for us Goods okay
18:42
that's that's the reason we have that
18:43
time what about import well Imports are
18:48
sort of the the Dual of that meaning of
18:51
the export function is is is is H is
18:54
actually our Imports is what the other
18:56
countries sees as their export okay
18:59
so our inputs will tend to go up when
19:02
domestic output goes up because if
19:04
domestic income goes up domestic
19:07
consumer say will both consume more
19:10
Goods at home but they will also consume
19:12
more Goods abroad no they going to scale
19:15
up their consumption and they're going
19:17
to consume consume from from both places
19:19
so
19:20
Imports H will is an increaseing
19:23
function of domestic
19:25
output what about the the real exchange
19:27
rate here well inputs are an increasing
19:31
function of the um real exchange rate
19:36
why is
19:40
that it's the same argument of export
19:43
but seem from the other
19:49
side remember when why do we use this
19:52
Epsilon 4 to decide where do we want to
19:54
buy our Goods if Epsilon goes up means
19:57
our Goods become more
20:00
expensive if our Goods become more
20:03
expensive for any given level of
20:05
domestic
20:06
consumption where do you think you'll
20:08
buy your goods you'll buy more abroad
20:11
are cheaper okay so then that's an
20:14
increasing function of NS
20:17
good any question about that because
20:19
these are the only sort of new
20:20
behavioral equations we're going to have
20:22
for for this
20:25
model and and what I'm going to do next
20:28
is I'm going to start from the same
20:29
model we had in in in I don't know
20:32
lecture two or three h and uh I'm going
20:36
to I'm going to add this these terms and
20:39
see how things change
20:42
okay okay good so let's do
20:46
that so
20:48
remember H I think the first curve that
20:52
would the the first the very first
20:54
diagram we had in this class was this
20:57
one this was just a demand for domestic
21:01
uh domestic demand sorry which was just
21:05
C plus I plus G it's an increasing
21:07
function here because consumption and
21:10
investment are increasing function of
21:12
output okay and then in close economy
21:15
what we did is we had a 45 degree line
21:18
here and we said in equilibrium output
21:20
equal to demand and therefore the
21:22
intersection of this curve with the 45
21:24
45 degree line gave us our equilibrium
21:27
output that's what we have
21:29
we need to change things a little bit
21:31
we're going to put the 45 degree line in
21:32
the next slide but we first need to this
21:37
is not the relevant demand for
21:39
domestically produced Goods so we need
21:40
to go from here to the demand that is
21:44
relevant for domestic producers okay so
21:47
the first thing we need to do is we need
21:49
to subtract Imports because part of the
21:52
demand will go for foreign
21:54
Goods okay and so that's what I'm doing
21:58
here
21:59
to this domestic demand I'm subract
22:01
subtracting the part that H that is
22:05
going to foreign Goods not domestic
22:07
Goods because this is not demand for
22:08
domestically produced Goods so obviously
22:11
this is a shift down but there is also
22:13
rotation why is
22:15
that you see obviously we're subtracting
22:18
imports from domestic demand so that
22:21
moves us down here but it's also it's
22:23
not a parallel
22:25
shift this curve becomes flatter
22:30
why is that in other words the decline
22:33
is larger for the different the Gap is
22:35
larger for high levels of income than
22:37
for low levels of income or output why
22:39
is
22:40
that depend on outut exactly is because
22:45
there's a positive marginal propensity
22:47
to import and so you'll import more if
22:51
output is higher okay and that's the
22:53
reason we have this C notice that this
22:57
also means well let me get to the end of
22:59
that and and of these diagrams and then
23:01
I'll get back to this so one step more
23:04
still this is not what I need to
23:07
integrate with my 45 degree line because
23:10
this is not the demand that domestic
23:11
producer will face we still have to add
23:14
the demand that comes from
23:16
foreigners and that's exports okay so to
23:19
this AA function I have to add exports
23:24
and exports is a parallel shift because
23:26
it didn't depend on domestic output it
23:28
depend on foreign output so foreign
23:29
output is going to be a parameter in
23:31
this curve but it's not doesn't change
23:33
the slope of that
23:35
curve so here we went from the DD curve
23:40
to the new curve which is the reant for
23:41
equilibrium domestic equilibrium output
23:43
which is this ZZ curve
23:48
okay now notice two things or one thing
23:52
about this ZZ curve relative to DD what
23:55
is the most obvious
23:58
difference between these two
24:03
curves no this is the one we use in
24:06
lecture two or three I don't know and
24:09
then when we did slm and all that and
24:11
this is the one we're going to use now
24:12
the
24:15
ZZ it's flatter yeah why is
24:20
that flatter is slow a slope will mean
24:23
lower
24:25
multiplier why is the multiplier lower
24:27
then you know open economy part of the
24:30
Dem falls on for exactly because part of
24:32
the remember the the way we got to the
24:35
multiplier is that income went up
24:37
consumption went up the that increased
24:40
income again and so on so forth but if
24:42
part of that increasing consumption is
24:44
going to foreign Goods that's not
24:46
reflected in demand for domestically
24:48
produced goods and therefore there's
24:49
less of a multiplier okay and that's one
24:52
characteristic of the open economy is
24:54
that the multipliers are
24:57
smaller the distinction is that you
24:59
don't see it here but we have more
25:02
parameters in particular a very
25:05
important parameter here is y star y
25:08
star didn't we didn't worry about what
25:09
was income in Germany when we look at
25:13
the islm the close economy model now we
25:15
worry about what the income of our main
25:18
trading partners is so you there's an
25:21
extra parameter there
25:23
good now we still haven't found
25:26
equilibrium output but there is a point
25:27
that is already interes in here which is
25:30
this
25:32
one what do I know of this point well in
25:35
this point domestic demand for goods is
25:38
the same as demand for domestically
25:40
produced goods for domestic goods and
25:43
that also means that the trade balance
25:46
is zero meaning that at that point
25:49
exports is exactly equal to Imports so
25:51
net exports are equal to zero okay so
25:55
that's what I'm plotting here actually
25:57
this is the net export function the net
25:59
export function is
26:03
simply that minus that divided by the
26:07
exchange rate okay so that's what I'm
26:09
plotting
26:10
here is a decreasing function of output
26:13
why is
26:15
that why is this decreasing in in
26:18
domestic
26:19
output remember this is export minus
26:23
UT divided by the exchanger but we're
26:26
not moving the exchanger for now
26:29
why is this decreasing that means here
26:33
exports exceed Imports here Imports
26:35
exceed exports so here you have a trade
26:38
deficit here you have a trade surplus
26:40
why why is that why is that the shape
26:43
why is it downward
26:52
SL import grow outp grows export exactly
26:57
export is not a function of domestic
26:58
output it's a function of foreign output
27:01
while while inputs is an increasing
27:03
function of domestic output a net export
27:06
is exports minus Imports okay so that's
27:10
what this is decreasing and this point
27:11
here happens to be when the two things
27:13
are exactly
27:15
balance that's trade balance happens to
27:18
be the point where DD is equal to ZZ
27:22
that's just there's no reason why
27:23
equilibrium output should be at that
27:24
level I'm saying that's a point where
27:26
that happens okay now we're going to
27:28
find equilibrium output to find to find
27:31
equilibrium output I'm going to erase
27:33
all this extra curves here and I'm just
27:35
going to keep the ZZ here because that's
27:38
the demand for domestically produced
27:40
goods and and I'm doing short run here
27:42
so I know that domestic production is
27:45
going that is the Y is going to be equal
27:48
to demand for domestic Goods it's it's a
27:50
demand determined model that's what the
27:52
short run is all about so erase all this
27:56
all these curves and I'm going to just
27:57
keep this ZZ curve there there you
28:01
are okay so now I have my 45 degree line
28:05
because in the short
28:07
run equilibrium output is equal to
28:10
aggregate demand aggregate demand for
28:13
what for domestically produced Goods
28:14
that's the reason I'm using ZZ not DD
28:18
okay but there you are then you do
28:20
exactly the same as we did before boom
28:22
that's our equilibrium outut and here
28:24
you can do all sort of experiments and
28:26
you're going to get the same sort of
28:27
things things that we there the
28:29
multiplier is a smaller multiplier but
28:30
you're going to still get a multiplier
28:32
and all these kind of things okay now I
28:36
this is just I I I in this example it
28:40
happens that at this equilibrium output
28:42
this country has a trade deficit I just
28:45
made up that
28:48
okay so the so this is the equilibrium
28:52
condition is output equal to Z output
28:55
equal to then domestic demand plus
28:58
export minus
29:00
input okay and then the net export is
29:03
just I'm plotting this term
29:06
here that's what we have here but
29:09
equilibrium is just y equal to Z it's
29:11
not this equal to
29:14
zero you can think about equilibrium but
29:18
this is this is what it is given that
29:20
that's equilibrium how
29:24
okay is this clear I mean this is the
29:27
start diagram of of this part of the
29:28
course so you need to understand this
29:32
diagram go over
29:35
it play with it think what is a
29:37
parameter in there and so I'm going to
29:39
do a little bit of that now but make
29:41
sure that you
29:43
understand
29:47
this okay so let a few things here so
29:50
let's do things that we did in close
29:52
economy so suppose that you have a f
29:55
fiscal
29:56
expansion so so what did we do when we
29:59
had a fysal expansion in lecture two or
30:00
three well that moves the ZZ curve up
30:04
output will go up and then there will be
30:06
a multiplier so output will go up by
30:08
more than the initial increasing
30:11
government expenditure no that's what we
30:14
had before it will go up by more but not
30:17
as
30:18
much as it did in the close economy so
30:22
the the increas in output will will be
30:24
more than the increase in government
30:25
expenditure but it will be not as much
30:28
as it would have been had we had a close
30:31
economy why is
30:39
that why is the last part
30:43
true why not as much as it would have
30:45
been in the close
30:50
economy well you can read it here is
30:53
because part of that extra energy the
30:55
man for consumption will go to foreign
30:57
Goods it will not come back to demand
30:59
more domestic production okay and that's
31:03
reflected in that the trade deficit in
31:05
this particular example we start with a
31:07
situation where the the we had a the
31:09
trade was balanced we had no net export
31:12
was equal to zero and we end up with a
31:14
trade
31:15
deficit that trade deficit is exactly
31:17
the same reason why we got a smaller
31:19
multiply is because part of the extra
31:21
demand that comes from the extra income
31:23
that created by the additional
31:25
expenditure H by the aggregate demand
31:28
effect of additional expenditure went to
31:30
the demand for foreign
31:32
Goods
31:39
okay good so do the same things we did
31:44
in in close Eon just practice here
31:45
increase taxes do things like that
31:48
increase
31:49
czo and see what happens both with
31:52
equilibrium output qualitatively will be
31:55
exactly the same as with you had in
31:56
close economy except that the effects
31:58
are going to be smaller but you're going
32:00
to get something new which is what
32:01
happens to the trade deficit as a result
32:06
okay
32:08
so this is a shock we couldn't do in the
32:10
close economy case which is what happens
32:13
if foreign demand go comes up that's
32:15
what I'm saying everyone is jubilant in
32:18
Emerging Market worlds because
32:20
China's output is going
32:23
up so what are all these economists
32:25
thinking say well China's output is
32:28
going up that means they're going to
32:29
import a lot more from
32:31
us okay that is they think our exports
32:35
are going to go up because
32:37
Chinese consumption is going
32:40
up well exports going up means up that
32:45
our ZZ curve moves
32:47
up okay so then what do you get well you
32:51
get
32:53
er now an increas in in
32:56
exports uh for any given level of income
32:59
means that eventually you you're going
33:01
to get higher output immediately but
33:02
higher output also has a multiplier
33:04
although smaller but at the end of the
33:06
day you're going to get higher
33:08
equilibrium out so it's great news
33:10
that's the reason they're so happy it's
33:11
great news that China is expanding
33:13
because it's also lead to an expansion
33:16
in h the rest of the
33:18
world okay so that's what you
33:22
get so that in that sense you know that
33:26
if if if China decides to do an
33:28
expansionary fiscal policy it also
33:31
expands us output or even more important
33:35
for Chilean output okay it does that so
33:38
it's the
33:39
same Chile could have done it by having
33:42
their own fiscal policy that would also
33:44
expanded output but it's wonderful that
33:47
China decides to do it because that
33:49
expands output as well with one
33:51
advantage two advantages what is but
33:55
there's one that you can see here which
33:57
is what
33:58
why is it that they prefer that China
34:00
does the effort rather than
34:01
me what looks better
34:07
here assume they are comparable size and
34:10
so on in terms of the impact in the in
34:13
the top diagram supposed to generate the
34:15
same increasing output as a result of
34:17
one policy which is my domestic
34:20
expansion in G which is what we did the
34:22
previous slide or because China's goes
34:25
into a boom and starts importing a lot
34:29
that's this we can we can export a lot
34:30
to them so suppose we get the same
34:33
increase in output what looks a little
34:35
better not a little better it can look a
34:38
lot
34:39
better there are two things but one is
34:41
in this
34:42
diagram which is remember if I did go in
34:45
expenditure the net export function
34:47
wouldn't have moved and I ended up with
34:49
higher output I would have ended up with
34:52
a bigger trade
34:53
deficit okay in this case it's export
34:58
driven so it's the opposite because the
35:00
now the net export function is Shifting
35:02
up you know if I move y star up I'm
35:05
moving export up that means the net
35:08
export function is moving up shifting up
35:11
and then I'm losing some of that because
35:13
in increasing domestic
35:14
output er um goes into input but at the
35:19
end of the day in this case I end up
35:21
with a trade surplus rather than a trade
35:25
deficit okay so lots of things that's
35:28
the reason when you open the world
35:30
there's a lot of free writing here you
35:32
want the other one to do the policies
35:33
for you because then then you're a lot
35:36
better you can get the same increase in
35:37
output but here you end up with a trade
35:39
surplus rather than a trade deficit and
35:42
there's a second thing that I'm not
35:43
showing you here there's a big
35:45
difference between you doing it you
35:46
domestically by increasing government
35:48
expenditure versus the other one doing
35:50
it for you and they're pulling you
35:52
through export what else will look
35:55
better in the US in this case relative
35:57
to the previous
36:01
slide that's but that's too
36:03
sophisticated we're still keeping the
36:04
interest rate
36:08
constant
36:09
H that's even more sophisticated this is
36:12
short run completely sticky prices
36:14
forget all
36:22
that fiscal deficits in the other one I
36:26
need to increase G so they had a fiscal
36:29
deficit here I don't need to do that and
36:32
in fact in reality taxes are typically
36:35
indexed to Output domestic output so
36:37
that that probably will improve the
36:39
deficit in the US
36:42
okay so
36:44
anyways the last point I want to H talk
36:48
about is another variable that we didn't
36:50
have in in the close economy which is
36:53
the role for the exchange rate what the
36:55
exchange rate can do and so for this we
36:58
need to look you know the only term that
37:00
depends on the exchange rate is this net
37:02
export term no the exports minus inputs
37:05
so what you know from net exports it's
37:07
very clear what happens to net exports
37:10
when we increase y star we did an
37:12
experiment before that's what increase
37:15
exports so net exports will increase if
37:18
you increase y star we also know that
37:21
net exports will decrease if domestic
37:23
output goes up because inputs increase
37:26
but from this expression is a little
37:28
ambiguous what happens to net exports
37:31
when there's a when the real exchange it
37:34
appreciates and it's a little it's a
37:37
little ambigous for the following
37:39
reason the volume
37:42
expression is clearly increasing in the
37:45
real exchange if us Goods become more
37:48
expensive you want to import more that's
37:50
what we discussed before but the value
37:53
may not be such because if you're
37:54
importing those goods in euros and now
37:56
the euro is cheaper for you then then
37:58
you may you're are paying less for each
38:01
unit you import okay now we're going to
38:04
assume from now on that this second
38:06
effect is not as strong as the volume
38:08
effect and that's a very realistic
38:09
assumption except for the very very very
38:11
short run okay so that's going to be our
38:14
assumption our assumption will be that
38:16
net exports decrease when the currency
38:20
appreciates if your goods become more
38:23
expensive then on net you're going to
38:25
have less net exports
38:27
okay as an assumption it simply says
38:30
that this guy in the numerator responds
38:32
more strongly than the denominator to a
38:34
depreciation to an appreciation of the
38:38
exchange so the quantity effect is much
38:41
more important than the price
38:44
effect so again I'm not going to have
38:48
trick questions about this or anything
38:49
I'm going to assume that from now that's
38:51
your assumption okay if I make a mistake
38:55
and and I try to trick you in in the
38:57
quiz for that you can charge me the
38:59
points okay I don't intend to do that
39:02
it's just IDE spot when one of the da
39:05
sort of wrote something there and
39:08
because this is the a very realistic
39:11
assumption good so now let's see what
39:14
happens then when the exchange rate
39:16
moves and let me use it ER suppose that
39:20
that you are in a situation where you
39:22
want to reduce the trade
39:24
deficit what would you do to so so the
39:27
experiment I have here has two
39:29
components but but let's talk about the
39:31
first one suppose that that you your
39:34
country has a big trade
39:36
deficit H and you want to reduce
39:39
that and the only tool you have is the
39:44
exchange rate what would you
39:49
do suppose you have trade deficit you
39:51
don't like that and you can move the
39:54
exchange rate around what would you do
40:00
yes you depreciate you make the domestic
40:02
Goods cheaper relative to the rest of
40:04
the world so you depreciate H your
40:08
currency which is the prices are
40:10
completely sticky fixed than nominal
40:13
depreciation means also real
40:15
depreciation and that will increase
40:17
increase net exports so what that will
40:19
do if you depreciate so X The Exchange
40:22
is also a parameter in this net export
40:24
function and given my assumption when
40:27
you depreciate the exchange rate then
40:29
then moves the net export function up
40:32
okay now the problem is that if you do
40:36
that that's also going to be
40:38
expansionary because now you know you
40:41
had certain equilibrium level of output
40:42
and now there's going to be expend
40:44
switching all around the world towards
40:46
your goods so you're going to end up
40:47
producing
40:48
more okay and so suppose that you didn't
40:52
want that extra production you just
40:54
wanted to fix your trade balance then
40:56
you have to said that and that's what
40:58
I've done here typ that's very typical
41:01
is supposed you're a situation where you
41:03
have very large trade deficit but you
41:05
are okay with the equilibrium level of
41:06
output you have and a typical package is
41:09
you depreciate your currency but you
41:11
also reduce govern expenditure okay
41:13
because depreciation of the currency is
41:15
expansionary it's expansionary improves
41:18
the trade deficit but it's also
41:19
expansionary because you relocate
41:20
expenditure both of residents and
41:23
foreigners towards your good that
41:24
increases demand for your good increases
41:26
out
41:27
but um
41:32
um I mean if I don't like that I have
41:35
many ways of of setting that one of them
41:37
is by reducing government expenditure
41:40
okay so that's what I've done
41:44
here again this is a great package you
41:47
see this is doing remember I told you
41:50
here
41:52
that people tend to prefer remember I
41:55
said you know this is this is one way of
41:58
of increasing output if you want to
42:00
increase output H um another
42:04
way is is to do it by exports
42:08
Rising if I don't want to increase out
42:10
but this is better because this
42:11
increases the trade balance well suppose
42:15
I do I which is where index is I do the
42:18
converse suppose I don't want to change
42:20
output I want to increase the net export
42:24
well these two charts this and the
42:26
previous one tell me exactly how to do
42:28
it I use this for the expansion of
42:31
output and to improve the net
42:33
exports and I use the other one to
42:35
offset the effect on
42:37
output but with the opposite
42:40
sign so I use this but with a decline in
42:44
G that's exactly what I did here so
42:47
that's very tempting for a country to
42:50
okay to depreciate the currency and at
42:53
the same time H if you think that you
42:56
need to pull off the economy then you
42:57
can use some other instrument domestic
43:00
instrument to to do that for a long time
43:03
China was accused of doing just this it
43:06
was called the mercantilist policies of
43:08
China and and especially sort of in late
43:12
90s and 2000s and so on China had
43:15
massive amount of exports and and the US
43:18
had huge trade deficit was called was
43:23
called the the the time of the global
43:25
imbalances big deficit in the US big
43:29
Surplus in in in in the in China and and
43:35
the rest of the world kept accusing
43:37
China of really M maintaining their
43:40
currency at artificially low levels okay
43:44
with the purpose of doing
43:47
that uh anyways I'm not going to take
43:51
sight on that I think that
43:55
that that the reason why the currency
43:57
was the Chinese REM was so depreciated
44:00
was different from that but that's a
44:02
different
44:03
story but the result was this it was
44:06
that they had very large trade
44:09
surpluses and uh the result was this
44:13
they had very large trade surpluses and
44:15
they grew a lot
44:17
so because they had this but it was very
44:21
export driven it was the rest of the
44:23
world pulling in fact the domestic
44:25
economy in China they were saying a lot
44:27
so domestic consumption was very low but
44:29
they had massive amount of exports and
44:31
that's what was P pulling their output
44:35
up so open economy you get new
44:39
tools okay so that's all that I want to
44:41
say for today um so
44:44
summary uh very important demand for
44:48
domestic Goods is no longer equal to
44:50
domestic uh demand for
44:53
goods because part of the latter will go
44:55
to a for foreign
44:57
goods and and also part of the former
45:01
will come from foreign demand okay so
45:03
that's that's a the that's what is new
45:06
of this part you have an extra component
45:08
and then the other thing that is new of
45:10
this part of the course is that well
45:12
these extra components the exports and
45:13
the Imports are functions of things that
45:15
w we didn't have before for an output
45:18
the exchange rate in particular
45:21
okay
45:23
um so equilibrium output again is the
45:26
determined by a output domestic output
45:31
equal to
45:32
that not to
45:36
that the difference between the two is
45:38
reflecting the trade
45:40
balance ER so the trade another way of
45:42
thinking about the trade balance is
45:44
simply the difference between the demand
45:47
for a um domestic goods and the domestic
45:51
demand for goods so the trade balance is
45:53
nothing else than that DD curve minus
45:55
the ZZ curve that's a trade balance okay
45:59
sorry the zzer minus the the deer that's
46:04
that's net
46:05
export okay sorry let me write that down
46:10
because so remember that we started from
46:14
the demand which was C + I + G that's
46:21
the domestic demand for
46:23
goods we went to Z e is equal to
46:30
demand
46:32
plus net
46:34
export okay so what I'm saying
46:38
is that net
46:42
export is just equal to Z minus D okay
46:48
so that's the reason you can very early
46:51
on
46:53
when I show you this thing here the if
46:56
distance between ZZ and d d is this n
47:02
export here okay that's a reason when
47:05
the two of them are the same that also
47:06
means that n export is equal to zero
47:10
very important also message from this
47:12
part of of of the course is that a
47:14
depreciation improves the trade balance
47:17
and increases the amount for domestic
47:18
Goods again that's what it's called
47:20
expenditure switching mechanism the
47:22
expenditures both of domestic of
47:26
residents and foreign switches towards
47:28
domestic
47:29
good
47:32
ER and that's also very important for a
47:35
given exchange rate changes in aggregate
47:37
demand in one large country H induced by
47:40
policy or the private sector in this
47:42
case China
47:43
reopening ER affects other countries
47:46
through why star through
47:49
exports okay so I'm going to stop here
47:53
and in the next lecture what we'll do is
47:54
we'll integrate this with the H
47:58
Financial opening and and that will get
48:00
us to what I think is one of the most
48:01
important malls in this course which is
48:03
called the Mandel flaming Mall
— end of transcript —
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