1 00:00:16,800 --> 00:00:20,760 so now we're going to go back to to the 2 00:00:18,920 --> 00:00:23,199 first part of the course in the sense 3 00:00:20,760 --> 00:00:25,920 that um 4 00:00:23,199 --> 00:00:28,160 um that we're going to go back to sort 5 00:00:25,920 --> 00:00:30,359 of the the short term okay so so we're 6 00:00:28,160 --> 00:00:33,000 going to essentially do the eslm mode 7 00:00:30,359 --> 00:00:35,800 again but now in the context of an open 8 00:00:33,000 --> 00:00:37,640 economy but before I get into that first 9 00:00:35,799 --> 00:00:39,038 model of this part of the course I want 10 00:00:37,640 --> 00:00:41,600 to 11 00:00:39,039 --> 00:00:44,160 um finish the previous 12 00:00:41,600 --> 00:00:46,520 lecture in which I was introducing the 13 00:00:44,159 --> 00:00:50,640 concept of openness and the key relative 14 00:00:46,520 --> 00:00:52,920 prices H in open economy and we stopped 15 00:00:50,640 --> 00:00:55,000 after discussing this and says well one 16 00:00:52,920 --> 00:00:58,399 of the things that that open an economy 17 00:00:55,000 --> 00:01:00,759 means is that now you can buy Goods both 18 00:00:58,399 --> 00:01:02,480 at home or abroad so you need to be able 19 00:01:00,759 --> 00:01:04,920 to compare these two different kind of 20 00:01:02,479 --> 00:01:07,158 goods and controlling for quality and 21 00:01:04,920 --> 00:01:08,879 all these differences and all that at 22 00:01:07,159 --> 00:01:11,118 the end of the day you want some sense 23 00:01:08,879 --> 00:01:13,640 of relative prices which good is more 24 00:01:11,118 --> 00:01:16,040 expensive than the other one and we said 25 00:01:13,640 --> 00:01:18,478 for that we use what is called the real 26 00:01:16,040 --> 00:01:21,118 exchange rate okay and we Define the 27 00:01:18,478 --> 00:01:24,920 real exchange rate as well essentially a 28 00:01:21,118 --> 00:01:28,200 it's the relative prices of of goods at 29 00:01:24,920 --> 00:01:29,560 home versus abroad H but we had to put 30 00:01:28,200 --> 00:01:30,880 them in a common currency that's the 31 00:01:29,560 --> 00:01:32,840 reason we we couldn't just directly 32 00:01:30,879 --> 00:01:35,158 compare the prices at home versus the 33 00:01:32,840 --> 00:01:37,920 prices abroad we had to convert the 34 00:01:35,159 --> 00:01:40,159 prices at home to the unit of account of 35 00:01:37,920 --> 00:01:41,640 the other country and then we could 36 00:01:40,159 --> 00:01:43,719 compare these two things and that's what 37 00:01:41,640 --> 00:01:46,319 we call the real exchange rate when that 38 00:01:43,719 --> 00:01:49,200 thing goes up we call that's a real 39 00:01:46,319 --> 00:01:52,599 appreciation of of of the local currency 40 00:01:49,200 --> 00:01:54,600 of the local economy and and that means 41 00:01:52,599 --> 00:01:57,359 that the goods domestic Goods become 42 00:01:54,599 --> 00:02:00,319 more expensive relative to International 43 00:01:57,359 --> 00:02:02,319 Goods when when the that Epsilon goes 44 00:02:00,319 --> 00:02:04,599 down then we call we say the real 45 00:02:02,319 --> 00:02:06,798 exchange has depreciated and that means 46 00:02:04,599 --> 00:02:09,280 that their domestic Goods become cheaper 47 00:02:06,799 --> 00:02:11,959 relative to foreign Goods okay so as a 48 00:02:09,280 --> 00:02:13,878 key Concept in the in what it means when 49 00:02:11,959 --> 00:02:16,319 you open an economy you need to have a 50 00:02:13,878 --> 00:02:18,518 this price is very important to decide 51 00:02:16,318 --> 00:02:20,000 whether you're going to again whether 52 00:02:18,519 --> 00:02:23,640 you and foreigners are going to buy 53 00:02:20,000 --> 00:02:25,519 Goods abroad or domestically the second 54 00:02:23,639 --> 00:02:28,119 concept of openness that we're going to 55 00:02:25,519 --> 00:02:29,920 explore in this course is openness in 56 00:02:28,120 --> 00:02:31,640 capital account in financial Market 57 00:02:29,919 --> 00:02:34,159 Market an openness in financial Market 58 00:02:31,639 --> 00:02:37,039 means something very similar which is 59 00:02:34,159 --> 00:02:38,959 now you when you have a dollar to invest 60 00:02:37,039 --> 00:02:41,359 financially invest not physical 61 00:02:38,959 --> 00:02:43,640 investment not real investment well you 62 00:02:41,360 --> 00:02:45,959 can decide whether to invest in domestic 63 00:02:43,639 --> 00:02:47,839 assets or foreign assets we're going to 64 00:02:45,959 --> 00:02:50,840 in this and later on we're going to talk 65 00:02:47,840 --> 00:02:52,719 about Equity but for now bonds so 66 00:02:50,840 --> 00:02:55,039 suppose you have a domestic Bond and a 67 00:02:52,719 --> 00:02:56,840 foreign bond well you can decide whether 68 00:02:55,039 --> 00:02:59,439 to invest in the domestic Bond or in the 69 00:02:56,840 --> 00:03:00,560 foreign bond okay now to make that 70 00:02:59,439 --> 00:03:03,799 compar 71 00:03:00,560 --> 00:03:06,439 Aron is not enough to have the current 72 00:03:03,799 --> 00:03:08,760 exchange rate because it doesn't mean 73 00:03:06,439 --> 00:03:11,719 much if I tell you that the British bond 74 00:03:08,759 --> 00:03:12,560 is more expensive than a domestic a 75 00:03:11,719 --> 00:03:15,199 dollar 76 00:03:12,560 --> 00:03:18,000 Bond H what you really need in order to 77 00:03:15,199 --> 00:03:20,280 decide where to invest is some sense 78 00:03:18,000 --> 00:03:22,120 what is the expected relative return of 79 00:03:20,280 --> 00:03:25,479 these two things do I expect to make 80 00:03:22,120 --> 00:03:30,480 more money in the dollar Bond or in the 81 00:03:25,479 --> 00:03:32,560 in the uh pound Bond and and I that's a 82 00:03:30,479 --> 00:03:35,199 comparison I need to be able to make 83 00:03:32,560 --> 00:03:36,759 okay there are also risk considerations 84 00:03:35,199 --> 00:03:38,958 and so on that we're going to not going 85 00:03:36,759 --> 00:03:42,318 to discuss in this in this course but 86 00:03:38,959 --> 00:03:44,239 the but the very basic comparison is not 87 00:03:42,318 --> 00:03:46,079 the value of things when you're talking 88 00:03:44,239 --> 00:03:48,840 about financial but what is a return you 89 00:03:46,080 --> 00:03:51,200 expect to get in one or the other okay 90 00:03:48,840 --> 00:03:53,799 so this is what you need to do suppose 91 00:03:51,199 --> 00:03:56,199 you have a dollar of invest dollar to 92 00:03:53,799 --> 00:03:58,239 invest and you have two options one is 93 00:03:56,199 --> 00:04:00,598 you buy a dollar Bond the dollar Bond 94 00:03:58,239 --> 00:04:05,079 gives you an interest rate of it so you 95 00:04:00,598 --> 00:04:06,639 know that say 5% nowadays more or less 96 00:04:05,079 --> 00:04:08,959 that if you have a dollar today and you 97 00:04:06,639 --> 00:04:11,238 invest it in a in a dollar Bond you're 98 00:04:08,959 --> 00:04:15,680 going to get Next Period you're going to 99 00:04:11,239 --> 00:04:18,798 get a h how much is it $100 supposed you 100 00:04:15,680 --> 00:04:21,400 have $1 then you're going to get a a 101 00:04:18,798 --> 00:04:26,279 five cents on that dollar at the end of 102 00:04:21,399 --> 00:04:28,279 the year okay and so that's what you get 103 00:04:26,279 --> 00:04:29,719 if you invest in the dollar Bond now 104 00:04:28,279 --> 00:04:32,000 you're given now an option because 105 00:04:29,720 --> 00:04:34,680 because we are open to financial markets 106 00:04:32,000 --> 00:04:37,680 to also invest in a British bond in a 107 00:04:34,680 --> 00:04:40,800 pound bond that is as safe as the US 108 00:04:37,680 --> 00:04:43,560 Bond say and uh so we're going to call 109 00:04:40,800 --> 00:04:46,199 that the UK Bond and I know for example 110 00:04:43,560 --> 00:04:49,680 that the UK bond is offering a 10% 111 00:04:46,199 --> 00:04:51,919 interest rate okay so suppose that I 112 00:04:49,680 --> 00:04:54,478 that I think IST star is 113 00:04:51,918 --> 00:04:56,359 10% then I ask you the question well 114 00:04:54,478 --> 00:04:58,159 does that mean that obviously since you 115 00:04:56,360 --> 00:05:00,199 want to compare returns that you should 116 00:04:58,160 --> 00:05:02,280 be investing in the 117 00:05:00,199 --> 00:05:05,600 in the pound bond in the UK Bond rather 118 00:05:02,279 --> 00:05:08,119 than the US Bond so suppose this is 5% 119 00:05:05,600 --> 00:05:09,680 and that's 10% and now tell you where do 120 00:05:08,120 --> 00:05:12,759 you want to invest your money do you 121 00:05:09,680 --> 00:05:13,879 want to invest it in the US Bond or in 122 00:05:12,759 --> 00:05:17,000 the UK 123 00:05:13,879 --> 00:05:19,759 Bond what is your 124 00:05:17,000 --> 00:05:24,120 answer sounds obvious no they pay you 125 00:05:19,759 --> 00:05:24,120 10% the other one pays you 5% 126 00:05:30,160 --> 00:05:34,039 exactly why do I need to know 127 00:05:34,360 --> 00:05:40,520 that exact so this this is not enough 128 00:05:38,038 --> 00:05:42,639 information for me because it may happen 129 00:05:40,519 --> 00:05:44,918 that what I get in terms of return I 130 00:05:42,639 --> 00:05:48,240 lose on the currency currency 131 00:05:44,918 --> 00:05:50,599 exposure for example so so let's see how 132 00:05:48,240 --> 00:05:53,759 that can happen so how would I do this I 133 00:05:50,600 --> 00:05:55,919 have $1 of wealth that I want to invest 134 00:05:53,759 --> 00:05:58,120 and suppose I want to go the UK Bond 135 00:05:55,918 --> 00:05:59,959 route so the first thing I have to do is 136 00:05:58,120 --> 00:06:03,160 I have to convert the dollar into pounds 137 00:05:59,959 --> 00:06:05,680 today to buy my dollar which my UK bond 138 00:06:03,160 --> 00:06:09,919 which will be in pounds so I first thing 139 00:06:05,680 --> 00:06:13,879 I have to use you know suppose I get 140 00:06:09,918 --> 00:06:18,680 8 pounds per dollar then then I I can 141 00:06:13,879 --> 00:06:19,719 invest .8 pounds in in in h in UK bonds 142 00:06:18,680 --> 00:06:24,680 with my 143 00:06:19,720 --> 00:06:29,599 dollar H that will give me8 * 1 plus 1 144 00:06:24,680 --> 00:06:32,319 point one 1 plus is star tomorrow but 145 00:06:29,598 --> 00:06:35,719 what are the units of this what do I get 146 00:06:32,319 --> 00:06:37,319 there next year what do I get next year 147 00:06:35,720 --> 00:06:44,120 I invested 148 00:06:37,319 --> 00:06:47,080 8 ER pounds and I got8 time 1.1 say 149 00:06:44,120 --> 00:06:50,840 pounds but I just told you so what I get 150 00:06:47,079 --> 00:06:53,359 next year is pounds I cannot compare a 151 00:06:50,839 --> 00:06:55,839 return in dollars which this was $ 152 00:06:53,360 --> 00:06:57,879 1.05 with a return on pounds I need to 153 00:06:55,839 --> 00:07:01,519 be able to convert those pounds pounds 154 00:06:57,879 --> 00:07:02,960 in the future to in the future and the 155 00:07:01,519 --> 00:07:06,120 best I can do here we're not going to 156 00:07:02,959 --> 00:07:08,439 open forward markets or anything is well 157 00:07:06,120 --> 00:07:10,079 I can that means I have to divide by the 158 00:07:08,439 --> 00:07:12,279 exchange rate next year to convert from 159 00:07:10,079 --> 00:07:14,399 pounds to dollars I don't know the 160 00:07:12,279 --> 00:07:17,279 exchange rate of next year so the best I 161 00:07:14,399 --> 00:07:20,679 can do is use expected exchange rate 162 00:07:17,279 --> 00:07:24,079 okay so so I divide this by the expected 163 00:07:20,680 --> 00:07:26,598 exchange rate next year and then I get 164 00:07:24,079 --> 00:07:30,279 that's my return in dollars of having 165 00:07:26,598 --> 00:07:33,319 gone the UK B route okay and so what I 166 00:07:30,279 --> 00:07:36,878 need to compare in order to decide where 167 00:07:33,319 --> 00:07:39,479 do I want to put my money is that return 168 00:07:36,879 --> 00:07:41,879 here versus that one there that's in the 169 00:07:39,478 --> 00:07:45,598 same units of account is I invest the 170 00:07:41,879 --> 00:07:48,199 same today $1 and I get dollars tomorrow 171 00:07:45,598 --> 00:07:48,199 so now I can 172 00:07:48,639 --> 00:07:53,879 compare and as you correctly pointed out 173 00:07:51,360 --> 00:07:56,639 this this this uh this thing here 174 00:07:53,879 --> 00:07:58,120 therefore requires that you you sort of 175 00:07:56,639 --> 00:08:00,319 think about what the exchange rate is 176 00:07:58,120 --> 00:08:03,800 likely to be tomorrow so for example in 177 00:08:00,319 --> 00:08:07,158 my example here when I said suppose I is 178 00:08:03,800 --> 00:08:09,158 5% and I star interest rate in UK bone 179 00:08:07,158 --> 00:08:12,038 is 10% is it obvious that they should 180 00:08:09,158 --> 00:08:14,360 invest in the in the UK Bond and the 181 00:08:12,038 --> 00:08:16,000 answer is no not so fast because I know 182 00:08:14,360 --> 00:08:18,080 I'm going to make 5% more in terms of 183 00:08:16,000 --> 00:08:19,959 the return of the bond but then when I 184 00:08:18,079 --> 00:08:22,598 convert it back to Dollar I may lose all 185 00:08:19,959 --> 00:08:25,638 that gain because the the the the pound 186 00:08:22,598 --> 00:08:27,439 has depreciated visis the dollar in 187 00:08:25,639 --> 00:08:30,079 particular if the pound I expect the 188 00:08:27,439 --> 00:08:32,559 pound to depreciate Rel to or if I 189 00:08:30,079 --> 00:08:35,079 expect the dollar to appreciate relative 190 00:08:32,559 --> 00:08:38,319 to the pound by 5% then I'm 191 00:08:35,080 --> 00:08:40,839 indifferent yeah in one case I get 192 00:08:38,320 --> 00:08:44,440 because if I go the the US Bond route I 193 00:08:40,839 --> 00:08:48,399 get five 5% next year from this year to 194 00:08:44,440 --> 00:08:50,959 next if I go the UK bone route I get 10% 195 00:08:48,399 --> 00:08:53,360 in return in the bond minus 5% in the 196 00:08:50,958 --> 00:08:55,399 capital loss due to the the the 197 00:08:53,360 --> 00:08:58,639 appreciation of the dollar so on net I 198 00:08:55,399 --> 00:09:00,078 get 5% as well that's what appears here 199 00:08:58,639 --> 00:09:02,078 that's what I've done here here so what 200 00:09:00,078 --> 00:09:03,799 I did here is say you know if the 201 00:09:02,078 --> 00:09:06,199 markets are very integrated and they 202 00:09:03,799 --> 00:09:08,559 function fairly well those two returns 203 00:09:06,200 --> 00:09:10,278 should be more or less similar in 204 00:09:08,559 --> 00:09:12,039 equilibrium because prices are going to 205 00:09:10,278 --> 00:09:15,639 adjust exchanges are going to adjust and 206 00:09:12,039 --> 00:09:17,559 so on so these two ways of investing are 207 00:09:15,639 --> 00:09:18,919 more or less the same I'm going to take 208 00:09:17,559 --> 00:09:20,359 the stream assumption that they are 209 00:09:18,919 --> 00:09:23,199 exactly the same 210 00:09:20,360 --> 00:09:24,959 here so that this holds that the 211 00:09:23,200 --> 00:09:26,720 equilibrium we have to find that 212 00:09:24,958 --> 00:09:29,078 equilibrium these two things are going 213 00:09:26,720 --> 00:09:30,800 to be equal that's called and it's a 214 00:09:29,078 --> 00:09:34,000 very important Concept in international 215 00:09:30,799 --> 00:09:36,479 finance the uncover inp parity condition 216 00:09:34,000 --> 00:09:39,759 don't ask me why it's uncover but it's 217 00:09:36,480 --> 00:09:41,639 it's the inp parity condition and and 218 00:09:39,759 --> 00:09:45,720 again that one in particular is called 219 00:09:41,639 --> 00:09:47,559 the uncover interp condition if you do a 220 00:09:45,720 --> 00:09:49,200 little bit of and this just tells you 221 00:09:47,559 --> 00:09:52,159 that in equilibrium you have to be more 222 00:09:49,200 --> 00:09:55,399 be indifferent between investing to in 223 00:09:52,159 --> 00:09:57,039 one bone or the other okay if you do a 224 00:09:55,399 --> 00:09:58,759 little algebra here of the kind of we 225 00:09:57,039 --> 00:10:03,319 have done in the past like you know 1 226 00:09:58,759 --> 00:10:03,319 plus I is I is approximately equal to 227 00:10:04,200 --> 00:10:11,079 one is approximately equal to 1 over 1 228 00:10:07,078 --> 00:10:14,159 minus I or or this one 1 plus I star is 229 00:10:11,078 --> 00:10:15,919 approximately equal to one over 1 minus 230 00:10:14,159 --> 00:10:19,159 I star and so on that's that kind of 231 00:10:15,919 --> 00:10:22,360 approximation tailor expansion when when 232 00:10:19,159 --> 00:10:24,919 these terms are small then you can write 233 00:10:22,360 --> 00:10:27,919 this as this expression 234 00:10:24,919 --> 00:10:30,078 here okay and this says exactly what I 235 00:10:27,919 --> 00:10:34,078 just said in words this says 236 00:10:30,078 --> 00:10:36,879 look if the interest rate in the US bond 237 00:10:34,078 --> 00:10:42,039 is lower than 238 00:10:36,879 --> 00:10:44,240 the than the UK bonds interest rate 239 00:10:42,039 --> 00:10:45,958 that's okay in the sense that we can be 240 00:10:44,240 --> 00:10:48,240 different between these two things as 241 00:10:45,958 --> 00:10:49,638 long as you're expecting a depre an 242 00:10:48,240 --> 00:10:52,360 appreciation of the 243 00:10:49,639 --> 00:10:54,919 dollar that is equivalent to the 244 00:10:52,360 --> 00:10:56,959 difference in this two interest rate 245 00:10:54,919 --> 00:10:59,559 okay so that's what's called the 246 00:10:56,958 --> 00:11:01,000 interest parity condition the two in 247 00:10:59,559 --> 00:11:03,838 equilibrium the two are going to be the 248 00:11:01,000 --> 00:11:05,679 same once you adjust for the expected 249 00:11:03,839 --> 00:11:09,600 appreciation or depreciation of the 250 00:11:05,679 --> 00:11:13,000 currency okay so in my example before we 251 00:11:09,600 --> 00:11:15,399 had this interest rate with 5% that was 252 00:11:13,000 --> 00:11:17,879 10% then the only way that will that's 253 00:11:15,399 --> 00:11:21,600 going to be an equilibrium is that if we 254 00:11:17,879 --> 00:11:24,679 also expect the dollar to appreciate by 255 00:11:21,600 --> 00:11:28,720 5% okay so dollar appreciation remember 256 00:11:24,679 --> 00:11:32,120 is this guy going up so if this is 5% 257 00:11:28,720 --> 00:11:33,600 then it's fine to have 5% here 10% there 258 00:11:32,120 --> 00:11:36,839 because they both gave me the same 259 00:11:33,600 --> 00:11:38,480 return in expectation at least okay if I 260 00:11:36,839 --> 00:11:41,440 do it in dollars I say I'm going to get 261 00:11:38,480 --> 00:11:44,159 5% either way invest in direct in 262 00:11:41,440 --> 00:11:46,279 dollars or through the UK pound because 263 00:11:44,159 --> 00:11:48,639 in the in the UK bone in the UK bone I'm 264 00:11:46,278 --> 00:11:51,159 going to get 10% and then lose 5% 265 00:11:48,639 --> 00:11:53,519 because of the of the currency or I can 266 00:11:51,159 --> 00:11:55,838 do the comparison in pounds and and then 267 00:11:53,519 --> 00:11:58,720 I say well I'm going to get 10% in 268 00:11:55,839 --> 00:12:00,519 pounds directly and if I go the US way 269 00:11:58,720 --> 00:12:02,879 I'm going to get 5% but I'm going to get 270 00:12:00,519 --> 00:12:06,639 also 5% in the currency appreciation and 271 00:12:02,879 --> 00:12:08,958 that gives me 10% okay key concept 272 00:12:06,639 --> 00:12:11,519 anyways so these are the two senses of 273 00:12:08,958 --> 00:12:13,919 opening that we can have opening in in 274 00:12:11,519 --> 00:12:16,839 Goods Market opening in financial 275 00:12:13,919 --> 00:12:19,879 markets and the the the key relative 276 00:12:16,839 --> 00:12:23,160 prices and and things are going to 277 00:12:19,879 --> 00:12:25,078 equilibrate both markets one is the real 278 00:12:23,159 --> 00:12:28,480 exchange rate in the Goods Market in 279 00:12:25,078 --> 00:12:30,519 this one is the uncovering transparity 280 00:12:28,480 --> 00:12:33,839 condition I want to shut down this part 281 00:12:30,519 --> 00:12:35,919 of openness H for a lecture or so and 282 00:12:33,839 --> 00:12:38,320 I'm going to focus now on the on the 283 00:12:35,919 --> 00:12:40,198 Goods Market open opening only okay and 284 00:12:38,320 --> 00:12:43,079 then I'm going to come back to this but 285 00:12:40,198 --> 00:12:46,759 I just wanted to show you the two senses 286 00:12:43,078 --> 00:12:49,679 of opening okay so now let's forget a 287 00:12:46,759 --> 00:12:53,039 little bit about financial opening and 288 00:12:49,679 --> 00:12:55,759 and uh and let's just focus on opening 289 00:12:53,039 --> 00:12:57,198 the goods markets to International Trade 290 00:12:55,759 --> 00:12:59,639 okay so that means we're going to have 291 00:12:57,198 --> 00:13:02,599 now imports and exports floating around 292 00:12:59,639 --> 00:13:05,799 so this is we go back again to our aslm 293 00:13:02,600 --> 00:13:07,839 mod H to actually want to go back to our 294 00:13:05,799 --> 00:13:09,639 Goods Market only mod the very first 295 00:13:07,839 --> 00:13:11,800 model we saw in this course but we're 296 00:13:09,639 --> 00:13:16,399 going to bring back a couple of terms 297 00:13:11,799 --> 00:13:17,879 that we shut down there okay now 298 00:13:16,399 --> 00:13:19,399 something that will be that we didn't 299 00:13:17,879 --> 00:13:22,399 need to worry about but we're going to 300 00:13:19,399 --> 00:13:23,759 have to worry about here a lot is that 301 00:13:22,399 --> 00:13:26,639 there is a distinction between the 302 00:13:23,759 --> 00:13:29,278 demand for domestic goods and the 303 00:13:26,639 --> 00:13:31,799 domestic demand for goods 304 00:13:29,278 --> 00:13:33,679 okay I know this going to be tricky but 305 00:13:31,799 --> 00:13:36,278 but okay there's a difference between 306 00:13:33,679 --> 00:13:39,120 demand for domestic Goods versus the 307 00:13:36,278 --> 00:13:42,480 domestic demand for goods this is what 308 00:13:39,120 --> 00:13:46,000 residents us say us residents household 309 00:13:42,480 --> 00:13:49,800 firms government demand in terms of 310 00:13:46,000 --> 00:13:51,519 goods this is how those same agents plus 311 00:13:49,799 --> 00:13:54,078 the rest of the world demand of 312 00:13:51,519 --> 00:13:56,159 domestically produced Goods that's the 313 00:13:54,078 --> 00:13:59,439 distinction when the economy was closed 314 00:13:56,159 --> 00:14:03,120 they were the same but now they're not 315 00:13:59,440 --> 00:14:06,240 okay so the domestic demand Remains the 316 00:14:03,120 --> 00:14:08,278 Same as before okay domestic demand is 317 00:14:06,240 --> 00:14:12,879 whatever the households demand 318 00:14:08,278 --> 00:14:14,879 consumption plus firm's investment plus 319 00:14:12,879 --> 00:14:18,000 government expenditure that's the same 320 00:14:14,879 --> 00:14:19,838 we had in close economy this hasn't 321 00:14:18,000 --> 00:14:21,879 changed the domestic demand is the same 322 00:14:19,839 --> 00:14:24,440 is a function of the same behavioral 323 00:14:21,879 --> 00:14:26,000 functions that we had there and the only 324 00:14:24,440 --> 00:14:28,079 behavioral function that was in the only 325 00:14:26,000 --> 00:14:29,600 two that we had was the consumption 326 00:14:28,078 --> 00:14:30,958 function and investment function 327 00:14:29,600 --> 00:14:33,920 remember so That Remains the Same 328 00:14:30,958 --> 00:14:36,679 nothing has changed what does change is 329 00:14:33,919 --> 00:14:38,360 that this is no longer what determines 330 00:14:36,679 --> 00:14:40,599 the demand for domestically produced 331 00:14:38,360 --> 00:14:43,759 goods and remember that's very key in 332 00:14:40,600 --> 00:14:45,480 the short run because this is so Canan 333 00:14:43,759 --> 00:14:48,600 model with very sticky prices demand 334 00:14:45,480 --> 00:14:50,278 determines output activity so if we're 335 00:14:48,600 --> 00:14:52,680 going to determine domestic production 336 00:14:50,278 --> 00:14:54,399 from demand we better be very careful 337 00:14:52,679 --> 00:14:57,078 about what is the demand for 338 00:14:54,399 --> 00:14:58,799 domestically produced Goods this is 339 00:14:57,078 --> 00:15:00,799 demand for both domestically produced 340 00:14:58,799 --> 00:15:02,399 good and foreign produced Goods some of 341 00:15:00,799 --> 00:15:04,719 those demand will be satisfied by 342 00:15:02,399 --> 00:15:06,440 Imports that's not demand for domestic 343 00:15:04,720 --> 00:15:08,800 production and therefore will not be 344 00:15:06,440 --> 00:15:11,120 determined equilibrium output 345 00:15:08,799 --> 00:15:13,758 domestically okay so this is going to be 346 00:15:11,120 --> 00:15:16,440 the New Concept which is demand for 347 00:15:13,759 --> 00:15:19,240 domestic goods and demand for domestic 348 00:15:16,440 --> 00:15:21,759 Goods is the same as demand as domestic 349 00:15:19,240 --> 00:15:24,480 demand for goods that the thing we had 350 00:15:21,759 --> 00:15:26,639 in close economy minus that part of 351 00:15:24,480 --> 00:15:28,600 demand that is Satisfied by Imports so 352 00:15:26,639 --> 00:15:30,480 minus Imports and divided by The 353 00:15:28,600 --> 00:15:32,040 Exchange because inputs may be priced in 354 00:15:30,480 --> 00:15:33,839 euros say and I have to convert them 355 00:15:32,039 --> 00:15:36,278 into dollars that's the reason very 356 00:15:33,839 --> 00:15:40,519 exchange don't worry about this for now 357 00:15:36,278 --> 00:15:44,639 okay so I had to subtract from that 358 00:15:40,519 --> 00:15:47,959 Imports because that's Demand by 359 00:15:44,639 --> 00:15:50,039 Resident us resident that doesn't go to 360 00:15:47,958 --> 00:15:52,638 demand to demand for domestically 361 00:15:50,039 --> 00:15:54,679 produced Goods it's demand for BMWs 362 00:15:52,639 --> 00:15:57,480 whatever so that's not going to affect 363 00:15:54,679 --> 00:15:58,479 the demand for Ford good cars and 364 00:15:57,480 --> 00:16:00,399 therefore it will not affect the 365 00:15:58,480 --> 00:16:04,039 production of four 366 00:16:00,399 --> 00:16:07,399 cars because it's not demand for that 367 00:16:04,039 --> 00:16:09,078 but against that we also have the demand 368 00:16:07,399 --> 00:16:11,159 a component of demand for domestically 369 00:16:09,078 --> 00:16:14,439 produced good that we didn't have before 370 00:16:11,159 --> 00:16:18,159 which is what foreigners demand from the 371 00:16:14,440 --> 00:16:21,319 US okay part of the demand that probably 372 00:16:18,159 --> 00:16:24,240 not for a lot at least part of the the 373 00:16:21,318 --> 00:16:27,519 demand that us 374 00:16:24,240 --> 00:16:30,039 Goods perceived us production perceived 375 00:16:27,519 --> 00:16:33,078 is not due to resident is due to 376 00:16:30,039 --> 00:16:36,360 foreigners that are importing us Goods 377 00:16:33,078 --> 00:16:37,559 okay Apple s sells a lot of phones to 378 00:16:36,360 --> 00:16:40,360 the rest of the 379 00:16:37,559 --> 00:16:42,479 world okay that's determined by Foreign 380 00:16:40,360 --> 00:16:46,318 demand for domestically produced good 381 00:16:42,480 --> 00:16:50,079 that's what we want to call X exports 382 00:16:46,318 --> 00:16:53,078 okay so this is our new key concept here 383 00:16:50,078 --> 00:16:55,120 Z okay which is the same as what we used 384 00:16:53,078 --> 00:16:58,919 to have but now we need to understand 385 00:16:55,120 --> 00:17:02,039 two more terms the export and it ask 386 00:16:58,919 --> 00:17:04,159 going to be a function and import which 387 00:17:02,039 --> 00:17:07,759 also will be a function so let me 388 00:17:04,160 --> 00:17:11,120 introduce that so exports we're going to 389 00:17:07,759 --> 00:17:13,000 assume simplify things but it's sensible 390 00:17:11,119 --> 00:17:15,438 behavioral assumption we're going to 391 00:17:13,000 --> 00:17:18,880 assume that exports are increasing in 392 00:17:15,439 --> 00:17:22,199 foreign output that's what y star 393 00:17:18,880 --> 00:17:24,880 means and it makes sense is the rest of 394 00:17:22,199 --> 00:17:27,400 the world I mean Emerging Market the 395 00:17:24,880 --> 00:17:30,760 commodity producing economies today are 396 00:17:27,400 --> 00:17:33,600 very excited about the recover in China 397 00:17:30,759 --> 00:17:36,079 no China is reopening so so it's a big 398 00:17:33,599 --> 00:17:37,879 boom domestically that's great news for 399 00:17:36,079 --> 00:17:40,079 the Emerging Markets commodity producers 400 00:17:37,880 --> 00:17:42,440 because that will increase the demand 401 00:17:40,079 --> 00:17:44,159 from China for goods produced around the 402 00:17:42,440 --> 00:17:47,200 world in particular in commodity 403 00:17:44,160 --> 00:17:49,558 producing economies so so that's what 404 00:17:47,200 --> 00:17:51,840 this is capturing if if an important 405 00:17:49,558 --> 00:17:53,480 trading partners output goes up income 406 00:17:51,839 --> 00:17:55,439 goes up then they're they're going to 407 00:17:53,480 --> 00:17:56,880 consume everything they're domestic 408 00:17:55,440 --> 00:17:59,080 Goods but they're also going to consume 409 00:17:56,880 --> 00:18:01,039 the goods they import which are our 410 00:17:59,079 --> 00:18:02,359 exports okay so that's the reason this 411 00:18:01,038 --> 00:18:06,640 is 412 00:18:02,359 --> 00:18:08,038 increasing ER exports are decreasing on 413 00:18:06,640 --> 00:18:10,759 the real exchange 414 00:18:08,038 --> 00:18:12,960 rate that's sensible assumption why why 415 00:18:10,759 --> 00:18:15,759 do you think it's a sensible assumption 416 00:18:12,960 --> 00:18:19,720 so why do you think that exports US 417 00:18:15,759 --> 00:18:23,480 exports are decreasing on the real 418 00:18:19,720 --> 00:18:23,480 exchange rate 419 00:18:26,279 --> 00:18:32,279 Epsilon for for foreign customers to BU 420 00:18:30,000 --> 00:18:34,558 exactly because then us Goods become 421 00:18:32,279 --> 00:18:36,119 more expensive relative to foreign Goods 422 00:18:34,558 --> 00:18:39,319 that's what a real exchange appreciation 423 00:18:36,119 --> 00:18:42,038 is and therefore there is L less demand 424 00:18:39,319 --> 00:18:43,839 for domestically for for us Goods okay 425 00:18:42,038 --> 00:18:48,480 that's that's the reason we have that 426 00:18:43,839 --> 00:18:51,240 time what about import well Imports are 427 00:18:48,480 --> 00:18:54,558 sort of the the Dual of that meaning of 428 00:18:51,240 --> 00:18:56,159 the export function is is is is H is 429 00:18:54,558 --> 00:18:59,240 actually our Imports is what the other 430 00:18:56,159 --> 00:19:02,280 countries sees as their export okay 431 00:18:59,240 --> 00:19:04,480 so our inputs will tend to go up when 432 00:19:02,279 --> 00:19:07,440 domestic output goes up because if 433 00:19:04,480 --> 00:19:10,360 domestic income goes up domestic 434 00:19:07,440 --> 00:19:12,519 consumer say will both consume more 435 00:19:10,359 --> 00:19:15,199 Goods at home but they will also consume 436 00:19:12,519 --> 00:19:17,038 more Goods abroad no they going to scale 437 00:19:15,200 --> 00:19:19,840 up their consumption and they're going 438 00:19:17,038 --> 00:19:20,798 to consume consume from from both places 439 00:19:19,839 --> 00:19:23,038 so 440 00:19:20,798 --> 00:19:25,240 Imports H will is an increaseing 441 00:19:23,038 --> 00:19:27,759 function of domestic 442 00:19:25,240 --> 00:19:31,038 output what about the the real exchange 443 00:19:27,759 --> 00:19:36,000 rate here well inputs are an increasing 444 00:19:31,038 --> 00:19:38,319 function of the um real exchange rate 445 00:19:36,000 --> 00:19:38,319 why is 446 00:19:40,919 --> 00:19:46,280 that it's the same argument of export 447 00:19:43,400 --> 00:19:46,280 but seem from the other 448 00:19:49,400 --> 00:19:54,880 side remember when why do we use this 449 00:19:52,880 --> 00:19:57,720 Epsilon 4 to decide where do we want to 450 00:19:54,880 --> 00:20:00,640 buy our Goods if Epsilon goes up means 451 00:19:57,720 --> 00:20:03,038 our Goods become more 452 00:20:00,640 --> 00:20:05,200 expensive if our Goods become more 453 00:20:03,038 --> 00:20:06,200 expensive for any given level of 454 00:20:05,200 --> 00:20:08,000 domestic 455 00:20:06,200 --> 00:20:11,440 consumption where do you think you'll 456 00:20:08,000 --> 00:20:14,359 buy your goods you'll buy more abroad 457 00:20:11,440 --> 00:20:17,320 are cheaper okay so then that's an 458 00:20:14,359 --> 00:20:19,519 increasing function of NS 459 00:20:17,319 --> 00:20:20,759 good any question about that because 460 00:20:19,519 --> 00:20:22,279 these are the only sort of new 461 00:20:20,759 --> 00:20:25,240 behavioral equations we're going to have 462 00:20:22,279 --> 00:20:28,119 for for this 463 00:20:25,240 --> 00:20:29,519 model and and what I'm going to do next 464 00:20:28,119 --> 00:20:32,399 is I'm going to start from the same 465 00:20:29,519 --> 00:20:36,359 model we had in in in I don't know 466 00:20:32,400 --> 00:20:39,360 lecture two or three h and uh I'm going 467 00:20:36,359 --> 00:20:42,119 to I'm going to add this these terms and 468 00:20:39,359 --> 00:20:46,240 see how things change 469 00:20:42,119 --> 00:20:48,399 okay okay good so let's do 470 00:20:46,240 --> 00:20:52,079 that so 471 00:20:48,400 --> 00:20:54,798 remember H I think the first curve that 472 00:20:52,079 --> 00:20:57,599 would the the first the very first 473 00:20:54,798 --> 00:21:01,839 diagram we had in this class was this 474 00:20:57,599 --> 00:21:05,199 one this was just a demand for domestic 475 00:21:01,839 --> 00:21:07,359 uh domestic demand sorry which was just 476 00:21:05,200 --> 00:21:10,319 C plus I plus G it's an increasing 477 00:21:07,359 --> 00:21:12,558 function here because consumption and 478 00:21:10,319 --> 00:21:15,678 investment are increasing function of 479 00:21:12,558 --> 00:21:18,158 output okay and then in close economy 480 00:21:15,679 --> 00:21:20,360 what we did is we had a 45 degree line 481 00:21:18,159 --> 00:21:22,480 here and we said in equilibrium output 482 00:21:20,359 --> 00:21:24,678 equal to demand and therefore the 483 00:21:22,480 --> 00:21:27,240 intersection of this curve with the 45 484 00:21:24,679 --> 00:21:29,038 45 degree line gave us our equilibrium 485 00:21:27,240 --> 00:21:31,038 output that's what we have 486 00:21:29,038 --> 00:21:32,919 we need to change things a little bit 487 00:21:31,038 --> 00:21:37,558 we're going to put the 45 degree line in 488 00:21:32,919 --> 00:21:39,400 the next slide but we first need to this 489 00:21:37,558 --> 00:21:40,960 is not the relevant demand for 490 00:21:39,400 --> 00:21:44,080 domestically produced Goods so we need 491 00:21:40,960 --> 00:21:47,278 to go from here to the demand that is 492 00:21:44,079 --> 00:21:49,558 relevant for domestic producers okay so 493 00:21:47,278 --> 00:21:52,200 the first thing we need to do is we need 494 00:21:49,558 --> 00:21:54,319 to subtract Imports because part of the 495 00:21:52,200 --> 00:21:58,080 demand will go for foreign 496 00:21:54,319 --> 00:21:59,158 Goods okay and so that's what I'm doing 497 00:21:58,079 --> 00:22:01,720 here 498 00:21:59,159 --> 00:22:05,000 to this domestic demand I'm subract 499 00:22:01,720 --> 00:22:07,519 subtracting the part that H that is 500 00:22:05,000 --> 00:22:08,960 going to foreign Goods not domestic 501 00:22:07,519 --> 00:22:11,839 Goods because this is not demand for 502 00:22:08,960 --> 00:22:13,840 domestically produced Goods so obviously 503 00:22:11,839 --> 00:22:15,439 this is a shift down but there is also 504 00:22:13,839 --> 00:22:18,399 rotation why is 505 00:22:15,440 --> 00:22:21,519 that you see obviously we're subtracting 506 00:22:18,400 --> 00:22:23,880 imports from domestic demand so that 507 00:22:21,519 --> 00:22:25,440 moves us down here but it's also it's 508 00:22:23,880 --> 00:22:30,278 not a parallel 509 00:22:25,440 --> 00:22:30,278 shift this curve becomes flatter 510 00:22:30,558 --> 00:22:35,278 why is that in other words the decline 511 00:22:33,240 --> 00:22:37,599 is larger for the different the Gap is 512 00:22:35,278 --> 00:22:39,919 larger for high levels of income than 513 00:22:37,599 --> 00:22:40,719 for low levels of income or output why 514 00:22:39,919 --> 00:22:45,559 is 515 00:22:40,720 --> 00:22:47,600 that depend on outut exactly is because 516 00:22:45,558 --> 00:22:51,038 there's a positive marginal propensity 517 00:22:47,599 --> 00:22:53,240 to import and so you'll import more if 518 00:22:51,038 --> 00:22:57,000 output is higher okay and that's the 519 00:22:53,240 --> 00:22:59,240 reason we have this C notice that this 520 00:22:57,000 --> 00:23:01,759 also means well let me get to the end of 521 00:22:59,240 --> 00:23:04,558 that and and of these diagrams and then 522 00:23:01,759 --> 00:23:07,400 I'll get back to this so one step more 523 00:23:04,558 --> 00:23:10,158 still this is not what I need to 524 00:23:07,400 --> 00:23:11,600 integrate with my 45 degree line because 525 00:23:10,159 --> 00:23:14,720 this is not the demand that domestic 526 00:23:11,599 --> 00:23:16,359 producer will face we still have to add 527 00:23:14,720 --> 00:23:19,880 the demand that comes from 528 00:23:16,359 --> 00:23:24,119 foreigners and that's exports okay so to 529 00:23:19,880 --> 00:23:26,000 this AA function I have to add exports 530 00:23:24,119 --> 00:23:28,038 and exports is a parallel shift because 531 00:23:26,000 --> 00:23:29,558 it didn't depend on domestic output it 532 00:23:28,038 --> 00:23:31,038 depend on foreign output so foreign 533 00:23:29,558 --> 00:23:33,720 output is going to be a parameter in 534 00:23:31,038 --> 00:23:35,679 this curve but it's not doesn't change 535 00:23:33,720 --> 00:23:40,000 the slope of that 536 00:23:35,679 --> 00:23:41,798 curve so here we went from the DD curve 537 00:23:40,000 --> 00:23:43,519 to the new curve which is the reant for 538 00:23:41,798 --> 00:23:48,558 equilibrium domestic equilibrium output 539 00:23:43,519 --> 00:23:52,000 which is this ZZ curve 540 00:23:48,558 --> 00:23:55,879 okay now notice two things or one thing 541 00:23:52,000 --> 00:23:58,640 about this ZZ curve relative to DD what 542 00:23:55,880 --> 00:24:01,559 is the most obvious 543 00:23:58,640 --> 00:24:01,559 difference between these two 544 00:24:03,319 --> 00:24:09,158 curves no this is the one we use in 545 00:24:06,400 --> 00:24:11,559 lecture two or three I don't know and 546 00:24:09,159 --> 00:24:12,880 then when we did slm and all that and 547 00:24:11,558 --> 00:24:15,038 this is the one we're going to use now 548 00:24:12,880 --> 00:24:15,039 the 549 00:24:15,519 --> 00:24:23,798 ZZ it's flatter yeah why is 550 00:24:20,480 --> 00:24:25,360 that flatter is slow a slope will mean 551 00:24:23,798 --> 00:24:27,720 lower 552 00:24:25,359 --> 00:24:30,199 multiplier why is the multiplier lower 553 00:24:27,720 --> 00:24:32,960 then you know open economy part of the 554 00:24:30,200 --> 00:24:35,360 Dem falls on for exactly because part of 555 00:24:32,960 --> 00:24:37,840 the remember the the way we got to the 556 00:24:35,359 --> 00:24:40,759 multiplier is that income went up 557 00:24:37,839 --> 00:24:42,639 consumption went up the that increased 558 00:24:40,759 --> 00:24:44,200 income again and so on so forth but if 559 00:24:42,640 --> 00:24:46,240 part of that increasing consumption is 560 00:24:44,200 --> 00:24:48,000 going to foreign Goods that's not 561 00:24:46,240 --> 00:24:49,399 reflected in demand for domestically 562 00:24:48,000 --> 00:24:52,519 produced goods and therefore there's 563 00:24:49,398 --> 00:24:54,398 less of a multiplier okay and that's one 564 00:24:52,519 --> 00:24:57,079 characteristic of the open economy is 565 00:24:54,398 --> 00:24:59,839 that the multipliers are 566 00:24:57,079 --> 00:25:02,319 smaller the distinction is that you 567 00:24:59,839 --> 00:25:05,359 don't see it here but we have more 568 00:25:02,319 --> 00:25:08,000 parameters in particular a very 569 00:25:05,359 --> 00:25:09,879 important parameter here is y star y 570 00:25:08,000 --> 00:25:13,119 star didn't we didn't worry about what 571 00:25:09,880 --> 00:25:15,720 was income in Germany when we look at 572 00:25:13,119 --> 00:25:18,038 the islm the close economy model now we 573 00:25:15,720 --> 00:25:21,240 worry about what the income of our main 574 00:25:18,038 --> 00:25:23,759 trading partners is so you there's an 575 00:25:21,240 --> 00:25:26,000 extra parameter there 576 00:25:23,759 --> 00:25:27,640 good now we still haven't found 577 00:25:26,000 --> 00:25:30,519 equilibrium output but there is a point 578 00:25:27,640 --> 00:25:32,600 that is already interes in here which is 579 00:25:30,519 --> 00:25:35,359 this 580 00:25:32,599 --> 00:25:38,319 one what do I know of this point well in 581 00:25:35,359 --> 00:25:40,599 this point domestic demand for goods is 582 00:25:38,319 --> 00:25:43,158 the same as demand for domestically 583 00:25:40,599 --> 00:25:46,278 produced goods for domestic goods and 584 00:25:43,159 --> 00:25:49,600 that also means that the trade balance 585 00:25:46,278 --> 00:25:51,919 is zero meaning that at that point 586 00:25:49,599 --> 00:25:55,759 exports is exactly equal to Imports so 587 00:25:51,919 --> 00:25:57,320 net exports are equal to zero okay so 588 00:25:55,759 --> 00:25:59,720 that's what I'm plotting here actually 589 00:25:57,319 --> 00:26:02,678 this is the net export function the net 590 00:25:59,720 --> 00:26:02,679 export function is 591 00:26:03,919 --> 00:26:09,679 simply that minus that divided by the 592 00:26:07,359 --> 00:26:10,839 exchange rate okay so that's what I'm 593 00:26:09,679 --> 00:26:13,640 plotting 594 00:26:10,839 --> 00:26:15,879 here is a decreasing function of output 595 00:26:13,640 --> 00:26:18,559 why is 596 00:26:15,880 --> 00:26:19,760 that why is this decreasing in in 597 00:26:18,558 --> 00:26:23,599 domestic 598 00:26:19,759 --> 00:26:26,079 output remember this is export minus 599 00:26:23,599 --> 00:26:29,879 UT divided by the exchanger but we're 600 00:26:26,079 --> 00:26:33,158 not moving the exchanger for now 601 00:26:29,880 --> 00:26:35,640 why is this decreasing that means here 602 00:26:33,159 --> 00:26:38,360 exports exceed Imports here Imports 603 00:26:35,640 --> 00:26:40,399 exceed exports so here you have a trade 604 00:26:38,359 --> 00:26:43,558 deficit here you have a trade surplus 605 00:26:40,398 --> 00:26:46,359 why why is that why is that the shape 606 00:26:43,558 --> 00:26:46,359 why is it downward 607 00:26:52,558 --> 00:26:58,639 SL import grow outp grows export exactly 608 00:26:57,000 --> 00:27:01,079 export is not a function of domestic 609 00:26:58,640 --> 00:27:03,799 output it's a function of foreign output 610 00:27:01,079 --> 00:27:06,918 while while inputs is an increasing 611 00:27:03,798 --> 00:27:10,119 function of domestic output a net export 612 00:27:06,919 --> 00:27:11,840 is exports minus Imports okay so that's 613 00:27:10,119 --> 00:27:13,439 what this is decreasing and this point 614 00:27:11,839 --> 00:27:15,079 here happens to be when the two things 615 00:27:13,440 --> 00:27:18,278 are exactly 616 00:27:15,079 --> 00:27:22,278 balance that's trade balance happens to 617 00:27:18,278 --> 00:27:23,599 be the point where DD is equal to ZZ 618 00:27:22,278 --> 00:27:24,919 that's just there's no reason why 619 00:27:23,599 --> 00:27:26,719 equilibrium output should be at that 620 00:27:24,919 --> 00:27:28,960 level I'm saying that's a point where 621 00:27:26,720 --> 00:27:31,919 that happens okay now we're going to 622 00:27:28,960 --> 00:27:33,399 find equilibrium output to find to find 623 00:27:31,919 --> 00:27:35,720 equilibrium output I'm going to erase 624 00:27:33,398 --> 00:27:38,359 all this extra curves here and I'm just 625 00:27:35,720 --> 00:27:40,319 going to keep the ZZ here because that's 626 00:27:38,359 --> 00:27:42,918 the demand for domestically produced 627 00:27:40,319 --> 00:27:45,720 goods and and I'm doing short run here 628 00:27:42,919 --> 00:27:48,038 so I know that domestic production is 629 00:27:45,720 --> 00:27:50,120 going that is the Y is going to be equal 630 00:27:48,038 --> 00:27:52,599 to demand for domestic Goods it's it's a 631 00:27:50,119 --> 00:27:56,439 demand determined model that's what the 632 00:27:52,599 --> 00:27:57,719 short run is all about so erase all this 633 00:27:56,440 --> 00:28:01,600 all these curves and I'm going to just 634 00:27:57,720 --> 00:28:05,919 keep this ZZ curve there there you 635 00:28:01,599 --> 00:28:07,798 are okay so now I have my 45 degree line 636 00:28:05,919 --> 00:28:10,559 because in the short 637 00:28:07,798 --> 00:28:13,319 run equilibrium output is equal to 638 00:28:10,558 --> 00:28:14,960 aggregate demand aggregate demand for 639 00:28:13,319 --> 00:28:18,119 what for domestically produced Goods 640 00:28:14,960 --> 00:28:20,319 that's the reason I'm using ZZ not DD 641 00:28:18,119 --> 00:28:22,359 okay but there you are then you do 642 00:28:20,319 --> 00:28:24,599 exactly the same as we did before boom 643 00:28:22,359 --> 00:28:26,879 that's our equilibrium outut and here 644 00:28:24,599 --> 00:28:27,918 you can do all sort of experiments and 645 00:28:26,880 --> 00:28:29,080 you're going to get the same sort of 646 00:28:27,919 --> 00:28:30,880 things things that we there the 647 00:28:29,079 --> 00:28:32,278 multiplier is a smaller multiplier but 648 00:28:30,880 --> 00:28:36,840 you're going to still get a multiplier 649 00:28:32,278 --> 00:28:40,640 and all these kind of things okay now I 650 00:28:36,839 --> 00:28:42,879 this is just I I I in this example it 651 00:28:40,640 --> 00:28:45,679 happens that at this equilibrium output 652 00:28:42,880 --> 00:28:48,320 this country has a trade deficit I just 653 00:28:45,679 --> 00:28:52,080 made up that 654 00:28:48,319 --> 00:28:55,839 okay so the so this is the equilibrium 655 00:28:52,079 --> 00:28:58,759 condition is output equal to Z output 656 00:28:55,839 --> 00:29:00,720 equal to then domestic demand plus 657 00:28:58,759 --> 00:29:03,879 export minus 658 00:29:00,720 --> 00:29:06,038 input okay and then the net export is 659 00:29:03,880 --> 00:29:09,360 just I'm plotting this term 660 00:29:06,038 --> 00:29:11,839 here that's what we have here but 661 00:29:09,359 --> 00:29:14,678 equilibrium is just y equal to Z it's 662 00:29:11,839 --> 00:29:18,839 not this equal to 663 00:29:14,679 --> 00:29:20,720 zero you can think about equilibrium but 664 00:29:18,839 --> 00:29:24,038 this is this is what it is given that 665 00:29:20,720 --> 00:29:24,038 that's equilibrium how 666 00:29:24,839 --> 00:29:28,839 okay is this clear I mean this is the 667 00:29:27,119 --> 00:29:32,439 start diagram of of this part of the 668 00:29:28,839 --> 00:29:32,439 course so you need to understand this 669 00:29:32,558 --> 00:29:37,918 diagram go over 670 00:29:35,240 --> 00:29:39,640 it play with it think what is a 671 00:29:37,919 --> 00:29:41,640 parameter in there and so I'm going to 672 00:29:39,640 --> 00:29:43,240 do a little bit of that now but make 673 00:29:41,640 --> 00:29:46,240 sure that you 674 00:29:43,240 --> 00:29:46,240 understand 675 00:29:47,599 --> 00:29:52,639 this okay so let a few things here so 676 00:29:50,798 --> 00:29:55,038 let's do things that we did in close 677 00:29:52,640 --> 00:29:56,759 economy so suppose that you have a f 678 00:29:55,038 --> 00:29:59,119 fiscal 679 00:29:56,759 --> 00:30:00,919 expansion so so what did we do when we 680 00:29:59,119 --> 00:30:04,479 had a fysal expansion in lecture two or 681 00:30:00,919 --> 00:30:06,919 three well that moves the ZZ curve up 682 00:30:04,480 --> 00:30:08,880 output will go up and then there will be 683 00:30:06,919 --> 00:30:11,000 a multiplier so output will go up by 684 00:30:08,880 --> 00:30:14,519 more than the initial increasing 685 00:30:11,000 --> 00:30:17,599 government expenditure no that's what we 686 00:30:14,519 --> 00:30:18,440 had before it will go up by more but not 687 00:30:17,599 --> 00:30:22,398 as 688 00:30:18,440 --> 00:30:24,200 much as it did in the close economy so 689 00:30:22,398 --> 00:30:25,879 the the increas in output will will be 690 00:30:24,200 --> 00:30:28,519 more than the increase in government 691 00:30:25,880 --> 00:30:31,480 expenditure but it will be not as much 692 00:30:28,519 --> 00:30:34,839 as it would have been had we had a close 693 00:30:31,480 --> 00:30:34,839 economy why is 694 00:30:39,960 --> 00:30:45,679 that why is the last part 695 00:30:43,359 --> 00:30:48,359 true why not as much as it would have 696 00:30:45,679 --> 00:30:48,360 been in the close 697 00:30:50,200 --> 00:30:55,639 economy well you can read it here is 698 00:30:53,278 --> 00:30:57,200 because part of that extra energy the 699 00:30:55,638 --> 00:30:59,879 man for consumption will go to foreign 700 00:30:57,200 --> 00:31:03,240 Goods it will not come back to demand 701 00:30:59,880 --> 00:31:05,240 more domestic production okay and that's 702 00:31:03,240 --> 00:31:07,000 reflected in that the trade deficit in 703 00:31:05,240 --> 00:31:09,759 this particular example we start with a 704 00:31:07,000 --> 00:31:12,200 situation where the the we had a the 705 00:31:09,759 --> 00:31:14,200 trade was balanced we had no net export 706 00:31:12,200 --> 00:31:15,080 was equal to zero and we end up with a 707 00:31:14,200 --> 00:31:17,720 trade 708 00:31:15,079 --> 00:31:19,439 deficit that trade deficit is exactly 709 00:31:17,720 --> 00:31:21,720 the same reason why we got a smaller 710 00:31:19,440 --> 00:31:23,519 multiply is because part of the extra 711 00:31:21,720 --> 00:31:25,639 demand that comes from the extra income 712 00:31:23,519 --> 00:31:28,079 that created by the additional 713 00:31:25,638 --> 00:31:30,759 expenditure H by the aggregate demand 714 00:31:28,079 --> 00:31:32,638 effect of additional expenditure went to 715 00:31:30,759 --> 00:31:35,638 the demand for foreign 716 00:31:32,638 --> 00:31:35,638 Goods 717 00:31:39,798 --> 00:31:45,960 okay good so do the same things we did 718 00:31:44,000 --> 00:31:48,038 in in close Eon just practice here 719 00:31:45,960 --> 00:31:49,759 increase taxes do things like that 720 00:31:48,038 --> 00:31:52,919 increase 721 00:31:49,759 --> 00:31:55,398 czo and see what happens both with 722 00:31:52,919 --> 00:31:56,759 equilibrium output qualitatively will be 723 00:31:55,398 --> 00:31:58,558 exactly the same as with you had in 724 00:31:56,759 --> 00:32:00,278 close economy except that the effects 725 00:31:58,558 --> 00:32:01,839 are going to be smaller but you're going 726 00:32:00,278 --> 00:32:06,519 to get something new which is what 727 00:32:01,839 --> 00:32:06,519 happens to the trade deficit as a result 728 00:32:06,599 --> 00:32:10,879 okay 729 00:32:08,440 --> 00:32:13,080 so this is a shock we couldn't do in the 730 00:32:10,880 --> 00:32:15,440 close economy case which is what happens 731 00:32:13,079 --> 00:32:18,199 if foreign demand go comes up that's 732 00:32:15,440 --> 00:32:20,360 what I'm saying everyone is jubilant in 733 00:32:18,200 --> 00:32:23,240 Emerging Market worlds because 734 00:32:20,359 --> 00:32:25,759 China's output is going 735 00:32:23,240 --> 00:32:28,519 up so what are all these economists 736 00:32:25,759 --> 00:32:29,798 thinking say well China's output is 737 00:32:28,519 --> 00:32:31,519 going up that means they're going to 738 00:32:29,798 --> 00:32:35,558 import a lot more from 739 00:32:31,519 --> 00:32:37,558 us okay that is they think our exports 740 00:32:35,558 --> 00:32:40,119 are going to go up because 741 00:32:37,558 --> 00:32:45,599 Chinese consumption is going 742 00:32:40,119 --> 00:32:47,918 up well exports going up means up that 743 00:32:45,599 --> 00:32:51,359 our ZZ curve moves 744 00:32:47,919 --> 00:32:53,440 up okay so then what do you get well you 745 00:32:51,359 --> 00:32:56,398 get 746 00:32:53,440 --> 00:32:59,159 er now an increas in in 747 00:32:56,398 --> 00:33:01,000 exports uh for any given level of income 748 00:32:59,159 --> 00:33:02,720 means that eventually you you're going 749 00:33:01,000 --> 00:33:04,558 to get higher output immediately but 750 00:33:02,720 --> 00:33:06,600 higher output also has a multiplier 751 00:33:04,558 --> 00:33:08,359 although smaller but at the end of the 752 00:33:06,599 --> 00:33:10,278 day you're going to get higher 753 00:33:08,359 --> 00:33:11,719 equilibrium out so it's great news 754 00:33:10,278 --> 00:33:13,240 that's the reason they're so happy it's 755 00:33:11,720 --> 00:33:16,038 great news that China is expanding 756 00:33:13,240 --> 00:33:18,440 because it's also lead to an expansion 757 00:33:16,038 --> 00:33:22,599 in h the rest of the 758 00:33:18,440 --> 00:33:26,200 world okay so that's what you 759 00:33:22,599 --> 00:33:28,439 get so that in that sense you know that 760 00:33:26,200 --> 00:33:31,480 if if if China decides to do an 761 00:33:28,440 --> 00:33:35,240 expansionary fiscal policy it also 762 00:33:31,480 --> 00:33:38,480 expands us output or even more important 763 00:33:35,240 --> 00:33:39,679 for Chilean output okay it does that so 764 00:33:38,480 --> 00:33:42,200 it's the 765 00:33:39,679 --> 00:33:44,559 same Chile could have done it by having 766 00:33:42,200 --> 00:33:47,720 their own fiscal policy that would also 767 00:33:44,558 --> 00:33:49,519 expanded output but it's wonderful that 768 00:33:47,720 --> 00:33:51,720 China decides to do it because that 769 00:33:49,519 --> 00:33:55,120 expands output as well with one 770 00:33:51,720 --> 00:33:57,440 advantage two advantages what is but 771 00:33:55,119 --> 00:33:58,518 there's one that you can see here which 772 00:33:57,440 --> 00:34:00,000 is what 773 00:33:58,519 --> 00:34:01,638 why is it that they prefer that China 774 00:34:00,000 --> 00:34:06,119 does the effort rather than 775 00:34:01,638 --> 00:34:06,119 me what looks better 776 00:34:07,398 --> 00:34:13,239 here assume they are comparable size and 777 00:34:10,320 --> 00:34:15,599 so on in terms of the impact in the in 778 00:34:13,239 --> 00:34:17,878 the top diagram supposed to generate the 779 00:34:15,599 --> 00:34:20,039 same increasing output as a result of 780 00:34:17,878 --> 00:34:22,358 one policy which is my domestic 781 00:34:20,039 --> 00:34:25,358 expansion in G which is what we did the 782 00:34:22,358 --> 00:34:29,000 previous slide or because China's goes 783 00:34:25,358 --> 00:34:30,679 into a boom and starts importing a lot 784 00:34:29,000 --> 00:34:33,039 that's this we can we can export a lot 785 00:34:30,679 --> 00:34:35,599 to them so suppose we get the same 786 00:34:33,039 --> 00:34:38,039 increase in output what looks a little 787 00:34:35,599 --> 00:34:39,119 better not a little better it can look a 788 00:34:38,039 --> 00:34:41,480 lot 789 00:34:39,119 --> 00:34:42,599 better there are two things but one is 790 00:34:41,480 --> 00:34:45,559 in this 791 00:34:42,599 --> 00:34:47,119 diagram which is remember if I did go in 792 00:34:45,559 --> 00:34:49,358 expenditure the net export function 793 00:34:47,119 --> 00:34:52,119 wouldn't have moved and I ended up with 794 00:34:49,358 --> 00:34:53,918 higher output I would have ended up with 795 00:34:52,119 --> 00:34:58,039 a bigger trade 796 00:34:53,918 --> 00:35:00,440 deficit okay in this case it's export 797 00:34:58,039 --> 00:35:02,960 driven so it's the opposite because the 798 00:35:00,440 --> 00:35:05,800 now the net export function is Shifting 799 00:35:02,960 --> 00:35:08,079 up you know if I move y star up I'm 800 00:35:05,800 --> 00:35:11,200 moving export up that means the net 801 00:35:08,079 --> 00:35:13,200 export function is moving up shifting up 802 00:35:11,199 --> 00:35:14,838 and then I'm losing some of that because 803 00:35:13,199 --> 00:35:19,118 in increasing domestic 804 00:35:14,838 --> 00:35:21,519 output er um goes into input but at the 805 00:35:19,119 --> 00:35:25,720 end of the day in this case I end up 806 00:35:21,519 --> 00:35:28,199 with a trade surplus rather than a trade 807 00:35:25,719 --> 00:35:30,879 deficit okay so lots of things that's 808 00:35:28,199 --> 00:35:32,399 the reason when you open the world 809 00:35:30,880 --> 00:35:33,800 there's a lot of free writing here you 810 00:35:32,400 --> 00:35:36,000 want the other one to do the policies 811 00:35:33,800 --> 00:35:37,560 for you because then then you're a lot 812 00:35:36,000 --> 00:35:39,559 better you can get the same increase in 813 00:35:37,559 --> 00:35:42,519 output but here you end up with a trade 814 00:35:39,559 --> 00:35:43,799 surplus rather than a trade deficit and 815 00:35:42,519 --> 00:35:45,159 there's a second thing that I'm not 816 00:35:43,800 --> 00:35:46,560 showing you here there's a big 817 00:35:45,159 --> 00:35:48,239 difference between you doing it you 818 00:35:46,559 --> 00:35:50,000 domestically by increasing government 819 00:35:48,239 --> 00:35:52,719 expenditure versus the other one doing 820 00:35:50,000 --> 00:35:55,039 it for you and they're pulling you 821 00:35:52,719 --> 00:35:57,919 through export what else will look 822 00:35:55,039 --> 00:36:00,440 better in the US in this case relative 823 00:35:57,920 --> 00:36:00,440 to the previous 824 00:36:01,519 --> 00:36:04,679 slide that's but that's too 825 00:36:03,280 --> 00:36:07,200 sophisticated we're still keeping the 826 00:36:04,679 --> 00:36:07,199 interest rate 827 00:36:08,239 --> 00:36:12,358 constant 828 00:36:09,760 --> 00:36:14,560 H that's even more sophisticated this is 829 00:36:12,358 --> 00:36:17,119 short run completely sticky prices 830 00:36:14,559 --> 00:36:17,119 forget all 831 00:36:22,679 --> 00:36:29,919 that fiscal deficits in the other one I 832 00:36:26,838 --> 00:36:32,239 need to increase G so they had a fiscal 833 00:36:29,920 --> 00:36:35,079 deficit here I don't need to do that and 834 00:36:32,239 --> 00:36:37,559 in fact in reality taxes are typically 835 00:36:35,079 --> 00:36:39,400 indexed to Output domestic output so 836 00:36:37,559 --> 00:36:42,358 that that probably will improve the 837 00:36:39,400 --> 00:36:44,559 deficit in the US 838 00:36:42,358 --> 00:36:48,358 okay so 839 00:36:44,559 --> 00:36:50,318 anyways the last point I want to H talk 840 00:36:48,358 --> 00:36:53,078 about is another variable that we didn't 841 00:36:50,318 --> 00:36:55,039 have in in the close economy which is 842 00:36:53,079 --> 00:36:58,119 the role for the exchange rate what the 843 00:36:55,039 --> 00:37:00,679 exchange rate can do and so for this we 844 00:36:58,119 --> 00:37:02,599 need to look you know the only term that 845 00:37:00,679 --> 00:37:05,799 depends on the exchange rate is this net 846 00:37:02,599 --> 00:37:07,880 export term no the exports minus inputs 847 00:37:05,800 --> 00:37:10,400 so what you know from net exports it's 848 00:37:07,880 --> 00:37:12,880 very clear what happens to net exports 849 00:37:10,400 --> 00:37:15,000 when we increase y star we did an 850 00:37:12,880 --> 00:37:18,200 experiment before that's what increase 851 00:37:15,000 --> 00:37:21,039 exports so net exports will increase if 852 00:37:18,199 --> 00:37:23,358 you increase y star we also know that 853 00:37:21,039 --> 00:37:26,880 net exports will decrease if domestic 854 00:37:23,358 --> 00:37:28,279 output goes up because inputs increase 855 00:37:26,880 --> 00:37:31,358 but from this expression is a little 856 00:37:28,280 --> 00:37:34,560 ambiguous what happens to net exports 857 00:37:31,358 --> 00:37:37,199 when there's a when the real exchange it 858 00:37:34,559 --> 00:37:39,000 appreciates and it's a little it's a 859 00:37:37,199 --> 00:37:42,318 little ambigous for the following 860 00:37:39,000 --> 00:37:45,400 reason the volume 861 00:37:42,318 --> 00:37:48,000 expression is clearly increasing in the 862 00:37:45,400 --> 00:37:50,119 real exchange if us Goods become more 863 00:37:48,000 --> 00:37:53,000 expensive you want to import more that's 864 00:37:50,119 --> 00:37:54,480 what we discussed before but the value 865 00:37:53,000 --> 00:37:56,960 may not be such because if you're 866 00:37:54,480 --> 00:37:58,960 importing those goods in euros and now 867 00:37:56,960 --> 00:38:01,119 the euro is cheaper for you then then 868 00:37:58,960 --> 00:38:04,318 you may you're are paying less for each 869 00:38:01,119 --> 00:38:06,160 unit you import okay now we're going to 870 00:38:04,318 --> 00:38:08,279 assume from now on that this second 871 00:38:06,159 --> 00:38:09,799 effect is not as strong as the volume 872 00:38:08,280 --> 00:38:11,880 effect and that's a very realistic 873 00:38:09,800 --> 00:38:14,800 assumption except for the very very very 874 00:38:11,880 --> 00:38:16,920 short run okay so that's going to be our 875 00:38:14,800 --> 00:38:20,839 assumption our assumption will be that 876 00:38:16,920 --> 00:38:23,318 net exports decrease when the currency 877 00:38:20,838 --> 00:38:25,838 appreciates if your goods become more 878 00:38:23,318 --> 00:38:27,960 expensive then on net you're going to 879 00:38:25,838 --> 00:38:30,440 have less net exports 880 00:38:27,960 --> 00:38:32,920 okay as an assumption it simply says 881 00:38:30,440 --> 00:38:34,920 that this guy in the numerator responds 882 00:38:32,920 --> 00:38:38,519 more strongly than the denominator to a 883 00:38:34,920 --> 00:38:41,318 depreciation to an appreciation of the 884 00:38:38,519 --> 00:38:44,559 exchange so the quantity effect is much 885 00:38:41,318 --> 00:38:44,559 more important than the price 886 00:38:44,960 --> 00:38:49,679 effect so again I'm not going to have 887 00:38:48,079 --> 00:38:51,680 trick questions about this or anything 888 00:38:49,679 --> 00:38:55,799 I'm going to assume that from now that's 889 00:38:51,679 --> 00:38:57,519 your assumption okay if I make a mistake 890 00:38:55,800 --> 00:38:59,599 and and I try to trick you in in the 891 00:38:57,519 --> 00:39:02,719 quiz for that you can charge me the 892 00:38:59,599 --> 00:39:05,880 points okay I don't intend to do that 893 00:39:02,719 --> 00:39:08,399 it's just IDE spot when one of the da 894 00:39:05,880 --> 00:39:11,760 sort of wrote something there and 895 00:39:08,400 --> 00:39:14,318 because this is the a very realistic 896 00:39:11,760 --> 00:39:16,640 assumption good so now let's see what 897 00:39:14,318 --> 00:39:20,920 happens then when the exchange rate 898 00:39:16,639 --> 00:39:22,078 moves and let me use it ER suppose that 899 00:39:20,920 --> 00:39:24,358 that you are in a situation where you 900 00:39:22,079 --> 00:39:27,839 want to reduce the trade 901 00:39:24,358 --> 00:39:29,318 deficit what would you do to so so the 902 00:39:27,838 --> 00:39:31,880 experiment I have here has two 903 00:39:29,318 --> 00:39:34,800 components but but let's talk about the 904 00:39:31,880 --> 00:39:36,440 first one suppose that that you your 905 00:39:34,800 --> 00:39:39,240 country has a big trade 906 00:39:36,440 --> 00:39:44,000 deficit H and you want to reduce 907 00:39:39,239 --> 00:39:47,679 that and the only tool you have is the 908 00:39:44,000 --> 00:39:47,679 exchange rate what would you 909 00:39:49,519 --> 00:39:54,880 do suppose you have trade deficit you 910 00:39:51,519 --> 00:39:59,318 don't like that and you can move the 911 00:39:54,880 --> 00:39:59,318 exchange rate around what would you do 912 00:40:00,280 --> 00:40:04,200 yes you depreciate you make the domestic 913 00:40:02,440 --> 00:40:08,000 Goods cheaper relative to the rest of 914 00:40:04,199 --> 00:40:10,000 the world so you depreciate H your 915 00:40:08,000 --> 00:40:13,440 currency which is the prices are 916 00:40:10,000 --> 00:40:15,480 completely sticky fixed than nominal 917 00:40:13,440 --> 00:40:17,440 depreciation means also real 918 00:40:15,480 --> 00:40:19,519 depreciation and that will increase 919 00:40:17,440 --> 00:40:22,720 increase net exports so what that will 920 00:40:19,519 --> 00:40:24,519 do if you depreciate so X The Exchange 921 00:40:22,719 --> 00:40:27,598 is also a parameter in this net export 922 00:40:24,519 --> 00:40:29,318 function and given my assumption when 923 00:40:27,599 --> 00:40:32,838 you depreciate the exchange rate then 924 00:40:29,318 --> 00:40:36,279 then moves the net export function up 925 00:40:32,838 --> 00:40:38,039 okay now the problem is that if you do 926 00:40:36,280 --> 00:40:41,240 that that's also going to be 927 00:40:38,039 --> 00:40:42,800 expansionary because now you know you 928 00:40:41,239 --> 00:40:44,519 had certain equilibrium level of output 929 00:40:42,800 --> 00:40:46,039 and now there's going to be expend 930 00:40:44,519 --> 00:40:47,079 switching all around the world towards 931 00:40:46,039 --> 00:40:48,759 your goods so you're going to end up 932 00:40:47,079 --> 00:40:52,318 producing 933 00:40:48,760 --> 00:40:54,640 more okay and so suppose that you didn't 934 00:40:52,318 --> 00:40:56,838 want that extra production you just 935 00:40:54,639 --> 00:40:58,920 wanted to fix your trade balance then 936 00:40:56,838 --> 00:41:01,639 you have to said that and that's what 937 00:40:58,920 --> 00:41:03,318 I've done here typ that's very typical 938 00:41:01,639 --> 00:41:05,400 is supposed you're a situation where you 939 00:41:03,318 --> 00:41:06,960 have very large trade deficit but you 940 00:41:05,400 --> 00:41:09,160 are okay with the equilibrium level of 941 00:41:06,960 --> 00:41:11,000 output you have and a typical package is 942 00:41:09,159 --> 00:41:13,519 you depreciate your currency but you 943 00:41:11,000 --> 00:41:15,838 also reduce govern expenditure okay 944 00:41:13,519 --> 00:41:18,199 because depreciation of the currency is 945 00:41:15,838 --> 00:41:19,279 expansionary it's expansionary improves 946 00:41:18,199 --> 00:41:20,838 the trade deficit but it's also 947 00:41:19,280 --> 00:41:23,119 expansionary because you relocate 948 00:41:20,838 --> 00:41:24,679 expenditure both of residents and 949 00:41:23,119 --> 00:41:26,640 foreigners towards your good that 950 00:41:24,679 --> 00:41:27,759 increases demand for your good increases 951 00:41:26,639 --> 00:41:31,838 out 952 00:41:27,760 --> 00:41:31,839 but um 953 00:41:32,199 --> 00:41:37,879 um I mean if I don't like that I have 954 00:41:35,079 --> 00:41:40,680 many ways of of setting that one of them 955 00:41:37,880 --> 00:41:43,880 is by reducing government expenditure 956 00:41:40,679 --> 00:41:43,879 okay so that's what I've done 957 00:41:44,920 --> 00:41:50,440 here again this is a great package you 958 00:41:47,719 --> 00:41:52,000 see this is doing remember I told you 959 00:41:50,440 --> 00:41:55,559 here 960 00:41:52,000 --> 00:41:58,559 that people tend to prefer remember I 961 00:41:55,559 --> 00:42:00,078 said you know this is this is one way of 962 00:41:58,559 --> 00:42:04,358 of increasing output if you want to 963 00:42:00,079 --> 00:42:08,200 increase output H um another 964 00:42:04,358 --> 00:42:10,440 way is is to do it by exports 965 00:42:08,199 --> 00:42:11,919 Rising if I don't want to increase out 966 00:42:10,440 --> 00:42:15,440 but this is better because this 967 00:42:11,920 --> 00:42:18,599 increases the trade balance well suppose 968 00:42:15,440 --> 00:42:20,679 I do I which is where index is I do the 969 00:42:18,599 --> 00:42:24,960 converse suppose I don't want to change 970 00:42:20,679 --> 00:42:26,639 output I want to increase the net export 971 00:42:24,960 --> 00:42:28,720 well these two charts this and the 972 00:42:26,639 --> 00:42:31,199 previous one tell me exactly how to do 973 00:42:28,719 --> 00:42:33,399 it I use this for the expansion of 974 00:42:31,199 --> 00:42:35,639 output and to improve the net 975 00:42:33,400 --> 00:42:37,039 exports and I use the other one to 976 00:42:35,639 --> 00:42:40,118 offset the effect on 977 00:42:37,039 --> 00:42:44,318 output but with the opposite 978 00:42:40,119 --> 00:42:47,920 sign so I use this but with a decline in 979 00:42:44,318 --> 00:42:50,519 G that's exactly what I did here so 980 00:42:47,920 --> 00:42:53,240 that's very tempting for a country to 981 00:42:50,519 --> 00:42:56,440 okay to depreciate the currency and at 982 00:42:53,239 --> 00:42:57,959 the same time H if you think that you 983 00:42:56,440 --> 00:43:00,039 need to pull off the economy then you 984 00:42:57,960 --> 00:43:03,559 can use some other instrument domestic 985 00:43:00,039 --> 00:43:06,239 instrument to to do that for a long time 986 00:43:03,559 --> 00:43:08,720 China was accused of doing just this it 987 00:43:06,239 --> 00:43:12,318 was called the mercantilist policies of 988 00:43:08,719 --> 00:43:15,480 China and and especially sort of in late 989 00:43:12,318 --> 00:43:18,838 90s and 2000s and so on China had 990 00:43:15,480 --> 00:43:23,639 massive amount of exports and and the US 991 00:43:18,838 --> 00:43:25,838 had huge trade deficit was called was 992 00:43:23,639 --> 00:43:29,519 called the the the time of the global 993 00:43:25,838 --> 00:43:35,519 imbalances big deficit in the US big 994 00:43:29,519 --> 00:43:37,119 Surplus in in in in the in China and and 995 00:43:35,519 --> 00:43:40,318 the rest of the world kept accusing 996 00:43:37,119 --> 00:43:44,760 China of really M maintaining their 997 00:43:40,318 --> 00:43:47,480 currency at artificially low levels okay 998 00:43:44,760 --> 00:43:51,599 with the purpose of doing 999 00:43:47,480 --> 00:43:55,280 that uh anyways I'm not going to take 1000 00:43:51,599 --> 00:43:55,280 sight on that I think that 1001 00:43:55,358 --> 00:44:00,719 that that the reason why the currency 1002 00:43:57,920 --> 00:44:02,159 was the Chinese REM was so depreciated 1003 00:44:00,719 --> 00:44:03,558 was different from that but that's a 1004 00:44:02,159 --> 00:44:06,639 different 1005 00:44:03,559 --> 00:44:09,960 story but the result was this it was 1006 00:44:06,639 --> 00:44:13,558 that they had very large trade 1007 00:44:09,960 --> 00:44:15,639 surpluses and uh the result was this 1008 00:44:13,559 --> 00:44:17,839 they had very large trade surpluses and 1009 00:44:15,639 --> 00:44:21,440 they grew a lot 1010 00:44:17,838 --> 00:44:23,119 so because they had this but it was very 1011 00:44:21,440 --> 00:44:25,720 export driven it was the rest of the 1012 00:44:23,119 --> 00:44:27,559 world pulling in fact the domestic 1013 00:44:25,719 --> 00:44:29,879 economy in China they were saying a lot 1014 00:44:27,559 --> 00:44:31,920 so domestic consumption was very low but 1015 00:44:29,880 --> 00:44:35,680 they had massive amount of exports and 1016 00:44:31,920 --> 00:44:39,559 that's what was P pulling their output 1017 00:44:35,679 --> 00:44:41,679 up so open economy you get new 1018 00:44:39,559 --> 00:44:44,960 tools okay so that's all that I want to 1019 00:44:41,679 --> 00:44:48,159 say for today um so 1020 00:44:44,960 --> 00:44:50,000 summary uh very important demand for 1021 00:44:48,159 --> 00:44:53,078 domestic Goods is no longer equal to 1022 00:44:50,000 --> 00:44:55,480 domestic uh demand for 1023 00:44:53,079 --> 00:44:57,800 goods because part of the latter will go 1024 00:44:55,480 --> 00:45:01,480 to a for foreign 1025 00:44:57,800 --> 00:45:03,839 goods and and also part of the former 1026 00:45:01,480 --> 00:45:06,400 will come from foreign demand okay so 1027 00:45:03,838 --> 00:45:08,880 that's that's a the that's what is new 1028 00:45:06,400 --> 00:45:10,440 of this part you have an extra component 1029 00:45:08,880 --> 00:45:12,119 and then the other thing that is new of 1030 00:45:10,440 --> 00:45:13,760 this part of the course is that well 1031 00:45:12,119 --> 00:45:15,440 these extra components the exports and 1032 00:45:13,760 --> 00:45:18,640 the Imports are functions of things that 1033 00:45:15,440 --> 00:45:21,358 w we didn't have before for an output 1034 00:45:18,639 --> 00:45:23,000 the exchange rate in particular 1035 00:45:21,358 --> 00:45:26,960 okay 1036 00:45:23,000 --> 00:45:31,239 um so equilibrium output again is the 1037 00:45:26,960 --> 00:45:32,639 determined by a output domestic output 1038 00:45:31,239 --> 00:45:36,118 equal to 1039 00:45:32,639 --> 00:45:36,118 that not to 1040 00:45:36,159 --> 00:45:40,279 that the difference between the two is 1041 00:45:38,519 --> 00:45:42,960 reflecting the trade 1042 00:45:40,280 --> 00:45:44,599 balance ER so the trade another way of 1043 00:45:42,960 --> 00:45:47,159 thinking about the trade balance is 1044 00:45:44,599 --> 00:45:51,119 simply the difference between the demand 1045 00:45:47,159 --> 00:45:53,318 for a um domestic goods and the domestic 1046 00:45:51,119 --> 00:45:55,680 demand for goods so the trade balance is 1047 00:45:53,318 --> 00:45:59,719 nothing else than that DD curve minus 1048 00:45:55,679 --> 00:46:04,159 the ZZ curve that's a trade balance okay 1049 00:45:59,719 --> 00:46:05,519 sorry the zzer minus the the deer that's 1050 00:46:04,159 --> 00:46:10,199 that's net 1051 00:46:05,519 --> 00:46:14,800 export okay sorry let me write that down 1052 00:46:10,199 --> 00:46:21,239 because so remember that we started from 1053 00:46:14,800 --> 00:46:23,800 the demand which was C + I + G that's 1054 00:46:21,239 --> 00:46:30,118 the domestic demand for 1055 00:46:23,800 --> 00:46:32,240 goods we went to Z e is equal to 1056 00:46:30,119 --> 00:46:34,079 demand 1057 00:46:32,239 --> 00:46:38,399 plus net 1058 00:46:34,079 --> 00:46:42,200 export okay so what I'm saying 1059 00:46:38,400 --> 00:46:42,200 is that net 1060 00:46:42,639 --> 00:46:51,400 export is just equal to Z minus D okay 1061 00:46:48,639 --> 00:46:53,118 so that's the reason you can very early 1062 00:46:51,400 --> 00:46:56,960 on 1063 00:46:53,119 --> 00:47:02,200 when I show you this thing here the if 1064 00:46:56,960 --> 00:47:05,000 distance between ZZ and d d is this n 1065 00:47:02,199 --> 00:47:06,759 export here okay that's a reason when 1066 00:47:05,000 --> 00:47:10,480 the two of them are the same that also 1067 00:47:06,760 --> 00:47:12,680 means that n export is equal to zero 1068 00:47:10,480 --> 00:47:14,679 very important also message from this 1069 00:47:12,679 --> 00:47:17,239 part of of of the course is that a 1070 00:47:14,679 --> 00:47:18,919 depreciation improves the trade balance 1071 00:47:17,239 --> 00:47:20,318 and increases the amount for domestic 1072 00:47:18,920 --> 00:47:22,880 Goods again that's what it's called 1073 00:47:20,318 --> 00:47:26,000 expenditure switching mechanism the 1074 00:47:22,880 --> 00:47:28,119 expenditures both of domestic of 1075 00:47:26,000 --> 00:47:29,440 residents and foreign switches towards 1076 00:47:28,119 --> 00:47:32,160 domestic 1077 00:47:29,440 --> 00:47:35,440 good 1078 00:47:32,159 --> 00:47:37,358 ER and that's also very important for a 1079 00:47:35,440 --> 00:47:40,720 given exchange rate changes in aggregate 1080 00:47:37,358 --> 00:47:42,400 demand in one large country H induced by 1081 00:47:40,719 --> 00:47:43,598 policy or the private sector in this 1082 00:47:42,400 --> 00:47:46,559 case China 1083 00:47:43,599 --> 00:47:49,800 reopening ER affects other countries 1084 00:47:46,559 --> 00:47:53,200 through why star through 1085 00:47:49,800 --> 00:47:54,800 exports okay so I'm going to stop here 1086 00:47:53,199 --> 00:47:58,000 and in the next lecture what we'll do is 1087 00:47:54,800 --> 00:48:00,039 we'll integrate this with the H 1088 00:47:58,000 --> 00:48:01,719 Financial opening and and that will get 1089 00:48:00,039 --> 00:48:03,279 us to what I think is one of the most 1090 00:48:01,719 --> 00:48:07,279 important malls in this course which is 1091 00:48:03,280 --> 00:48:07,280 called the Mandel flaming Mall