WEBVTT 00:00:16.800 --> 00:00:20.760 so now we're going to go back to to the 00:00:18.920 --> 00:00:23.199 first part of the course in the sense 00:00:20.760 --> 00:00:25.920 that um 00:00:23.199 --> 00:00:28.160 um that we're going to go back to sort 00:00:25.920 --> 00:00:30.359 of the the short term okay so so we're 00:00:28.160 --> 00:00:33.000 going to essentially do the eslm mode 00:00:30.359 --> 00:00:35.800 again but now in the context of an open 00:00:33.000 --> 00:00:37.640 economy but before I get into that first 00:00:35.799 --> 00:00:39.038 model of this part of the course I want 00:00:37.640 --> 00:00:41.600 to 00:00:39.039 --> 00:00:44.160 um finish the previous 00:00:41.600 --> 00:00:46.520 lecture in which I was introducing the 00:00:44.159 --> 00:00:50.640 concept of openness and the key relative 00:00:46.520 --> 00:00:52.920 prices H in open economy and we stopped 00:00:50.640 --> 00:00:55.000 after discussing this and says well one 00:00:52.920 --> 00:00:58.399 of the things that that open an economy 00:00:55.000 --> 00:01:00.759 means is that now you can buy Goods both 00:00:58.399 --> 00:01:02.480 at home or abroad so you need to be able 00:01:00.759 --> 00:01:04.920 to compare these two different kind of 00:01:02.479 --> 00:01:07.158 goods and controlling for quality and 00:01:04.920 --> 00:01:08.879 all these differences and all that at 00:01:07.159 --> 00:01:11.118 the end of the day you want some sense 00:01:08.879 --> 00:01:13.640 of relative prices which good is more 00:01:11.118 --> 00:01:16.040 expensive than the other one and we said 00:01:13.640 --> 00:01:18.478 for that we use what is called the real 00:01:16.040 --> 00:01:21.118 exchange rate okay and we Define the 00:01:18.478 --> 00:01:24.920 real exchange rate as well essentially a 00:01:21.118 --> 00:01:28.200 it's the relative prices of of goods at 00:01:24.920 --> 00:01:29.560 home versus abroad H but we had to put 00:01:28.200 --> 00:01:30.880 them in a common currency that's the 00:01:29.560 --> 00:01:32.840 reason we we couldn't just directly 00:01:30.879 --> 00:01:35.158 compare the prices at home versus the 00:01:32.840 --> 00:01:37.920 prices abroad we had to convert the 00:01:35.159 --> 00:01:40.159 prices at home to the unit of account of 00:01:37.920 --> 00:01:41.640 the other country and then we could 00:01:40.159 --> 00:01:43.719 compare these two things and that's what 00:01:41.640 --> 00:01:46.319 we call the real exchange rate when that 00:01:43.719 --> 00:01:49.200 thing goes up we call that's a real 00:01:46.319 --> 00:01:52.599 appreciation of of of the local currency 00:01:49.200 --> 00:01:54.600 of the local economy and and that means 00:01:52.599 --> 00:01:57.359 that the goods domestic Goods become 00:01:54.599 --> 00:02:00.319 more expensive relative to International 00:01:57.359 --> 00:02:02.319 Goods when when the that Epsilon goes 00:02:00.319 --> 00:02:04.599 down then we call we say the real 00:02:02.319 --> 00:02:06.798 exchange has depreciated and that means 00:02:04.599 --> 00:02:09.280 that their domestic Goods become cheaper 00:02:06.799 --> 00:02:11.959 relative to foreign Goods okay so as a 00:02:09.280 --> 00:02:13.878 key Concept in the in what it means when 00:02:11.959 --> 00:02:16.319 you open an economy you need to have a 00:02:13.878 --> 00:02:18.518 this price is very important to decide 00:02:16.318 --> 00:02:20.000 whether you're going to again whether 00:02:18.519 --> 00:02:23.640 you and foreigners are going to buy 00:02:20.000 --> 00:02:25.519 Goods abroad or domestically the second 00:02:23.639 --> 00:02:28.119 concept of openness that we're going to 00:02:25.519 --> 00:02:29.920 explore in this course is openness in 00:02:28.120 --> 00:02:31.640 capital account in financial Market 00:02:29.919 --> 00:02:34.159 Market an openness in financial Market 00:02:31.639 --> 00:02:37.039 means something very similar which is 00:02:34.159 --> 00:02:38.959 now you when you have a dollar to invest 00:02:37.039 --> 00:02:41.359 financially invest not physical 00:02:38.959 --> 00:02:43.640 investment not real investment well you 00:02:41.360 --> 00:02:45.959 can decide whether to invest in domestic 00:02:43.639 --> 00:02:47.839 assets or foreign assets we're going to 00:02:45.959 --> 00:02:50.840 in this and later on we're going to talk 00:02:47.840 --> 00:02:52.719 about Equity but for now bonds so 00:02:50.840 --> 00:02:55.039 suppose you have a domestic Bond and a 00:02:52.719 --> 00:02:56.840 foreign bond well you can decide whether 00:02:55.039 --> 00:02:59.439 to invest in the domestic Bond or in the 00:02:56.840 --> 00:03:00.560 foreign bond okay now to make that 00:02:59.439 --> 00:03:03.799 compar 00:03:00.560 --> 00:03:06.439 Aron is not enough to have the current 00:03:03.799 --> 00:03:08.760 exchange rate because it doesn't mean 00:03:06.439 --> 00:03:11.719 much if I tell you that the British bond 00:03:08.759 --> 00:03:12.560 is more expensive than a domestic a 00:03:11.719 --> 00:03:15.199 dollar 00:03:12.560 --> 00:03:18.000 Bond H what you really need in order to 00:03:15.199 --> 00:03:20.280 decide where to invest is some sense 00:03:18.000 --> 00:03:22.120 what is the expected relative return of 00:03:20.280 --> 00:03:25.479 these two things do I expect to make 00:03:22.120 --> 00:03:30.480 more money in the dollar Bond or in the 00:03:25.479 --> 00:03:32.560 in the uh pound Bond and and I that's a 00:03:30.479 --> 00:03:35.199 comparison I need to be able to make 00:03:32.560 --> 00:03:36.759 okay there are also risk considerations 00:03:35.199 --> 00:03:38.958 and so on that we're going to not going 00:03:36.759 --> 00:03:42.318 to discuss in this in this course but 00:03:38.959 --> 00:03:44.239 the but the very basic comparison is not 00:03:42.318 --> 00:03:46.079 the value of things when you're talking 00:03:44.239 --> 00:03:48.840 about financial but what is a return you 00:03:46.080 --> 00:03:51.200 expect to get in one or the other okay 00:03:48.840 --> 00:03:53.799 so this is what you need to do suppose 00:03:51.199 --> 00:03:56.199 you have a dollar of invest dollar to 00:03:53.799 --> 00:03:58.239 invest and you have two options one is 00:03:56.199 --> 00:04:00.598 you buy a dollar Bond the dollar Bond 00:03:58.239 --> 00:04:05.079 gives you an interest rate of it so you 00:04:00.598 --> 00:04:06.639 know that say 5% nowadays more or less 00:04:05.079 --> 00:04:08.959 that if you have a dollar today and you 00:04:06.639 --> 00:04:11.238 invest it in a in a dollar Bond you're 00:04:08.959 --> 00:04:15.680 going to get Next Period you're going to 00:04:11.239 --> 00:04:18.798 get a h how much is it $100 supposed you 00:04:15.680 --> 00:04:21.400 have $1 then you're going to get a a 00:04:18.798 --> 00:04:26.279 five cents on that dollar at the end of 00:04:21.399 --> 00:04:28.279 the year okay and so that's what you get 00:04:26.279 --> 00:04:29.719 if you invest in the dollar Bond now 00:04:28.279 --> 00:04:32.000 you're given now an option because 00:04:29.720 --> 00:04:34.680 because we are open to financial markets 00:04:32.000 --> 00:04:37.680 to also invest in a British bond in a 00:04:34.680 --> 00:04:40.800 pound bond that is as safe as the US 00:04:37.680 --> 00:04:43.560 Bond say and uh so we're going to call 00:04:40.800 --> 00:04:46.199 that the UK Bond and I know for example 00:04:43.560 --> 00:04:49.680 that the UK bond is offering a 10% 00:04:46.199 --> 00:04:51.919 interest rate okay so suppose that I 00:04:49.680 --> 00:04:54.478 that I think IST star is 00:04:51.918 --> 00:04:56.359 10% then I ask you the question well 00:04:54.478 --> 00:04:58.159 does that mean that obviously since you 00:04:56.360 --> 00:05:00.199 want to compare returns that you should 00:04:58.160 --> 00:05:02.280 be investing in the 00:05:00.199 --> 00:05:05.600 in the pound bond in the UK Bond rather 00:05:02.279 --> 00:05:08.119 than the US Bond so suppose this is 5% 00:05:05.600 --> 00:05:09.680 and that's 10% and now tell you where do 00:05:08.120 --> 00:05:12.759 you want to invest your money do you 00:05:09.680 --> 00:05:13.879 want to invest it in the US Bond or in 00:05:12.759 --> 00:05:17.000 the UK 00:05:13.879 --> 00:05:19.759 Bond what is your 00:05:17.000 --> 00:05:24.120 answer sounds obvious no they pay you 00:05:19.759 --> 00:05:24.120 10% the other one pays you 5% 00:05:30.160 --> 00:05:34.039 exactly why do I need to know 00:05:34.360 --> 00:05:40.520 that exact so this this is not enough 00:05:38.038 --> 00:05:42.639 information for me because it may happen 00:05:40.519 --> 00:05:44.918 that what I get in terms of return I 00:05:42.639 --> 00:05:48.240 lose on the currency currency 00:05:44.918 --> 00:05:50.599 exposure for example so so let's see how 00:05:48.240 --> 00:05:53.759 that can happen so how would I do this I 00:05:50.600 --> 00:05:55.919 have $1 of wealth that I want to invest 00:05:53.759 --> 00:05:58.120 and suppose I want to go the UK Bond 00:05:55.918 --> 00:05:59.959 route so the first thing I have to do is 00:05:58.120 --> 00:06:03.160 I have to convert the dollar into pounds 00:05:59.959 --> 00:06:05.680 today to buy my dollar which my UK bond 00:06:03.160 --> 00:06:09.919 which will be in pounds so I first thing 00:06:05.680 --> 00:06:13.879 I have to use you know suppose I get 00:06:09.918 --> 00:06:18.680 8 pounds per dollar then then I I can 00:06:13.879 --> 00:06:19.719 invest .8 pounds in in in h in UK bonds 00:06:18.680 --> 00:06:24.680 with my 00:06:19.720 --> 00:06:29.599 dollar H that will give me8 * 1 plus 1 00:06:24.680 --> 00:06:32.319 point one 1 plus is star tomorrow but 00:06:29.598 --> 00:06:35.719 what are the units of this what do I get 00:06:32.319 --> 00:06:37.319 there next year what do I get next year 00:06:35.720 --> 00:06:44.120 I invested 00:06:37.319 --> 00:06:47.080 8 ER pounds and I got8 time 1.1 say 00:06:44.120 --> 00:06:50.840 pounds but I just told you so what I get 00:06:47.079 --> 00:06:53.359 next year is pounds I cannot compare a 00:06:50.839 --> 00:06:55.839 return in dollars which this was $ 00:06:53.360 --> 00:06:57.879 1.05 with a return on pounds I need to 00:06:55.839 --> 00:07:01.519 be able to convert those pounds pounds 00:06:57.879 --> 00:07:02.960 in the future to in the future and the 00:07:01.519 --> 00:07:06.120 best I can do here we're not going to 00:07:02.959 --> 00:07:08.439 open forward markets or anything is well 00:07:06.120 --> 00:07:10.079 I can that means I have to divide by the 00:07:08.439 --> 00:07:12.279 exchange rate next year to convert from 00:07:10.079 --> 00:07:14.399 pounds to dollars I don't know the 00:07:12.279 --> 00:07:17.279 exchange rate of next year so the best I 00:07:14.399 --> 00:07:20.679 can do is use expected exchange rate 00:07:17.279 --> 00:07:24.079 okay so so I divide this by the expected 00:07:20.680 --> 00:07:26.598 exchange rate next year and then I get 00:07:24.079 --> 00:07:30.279 that's my return in dollars of having 00:07:26.598 --> 00:07:33.319 gone the UK B route okay and so what I 00:07:30.279 --> 00:07:36.878 need to compare in order to decide where 00:07:33.319 --> 00:07:39.479 do I want to put my money is that return 00:07:36.879 --> 00:07:41.879 here versus that one there that's in the 00:07:39.478 --> 00:07:45.598 same units of account is I invest the 00:07:41.879 --> 00:07:48.199 same today $1 and I get dollars tomorrow 00:07:45.598 --> 00:07:48.199 so now I can 00:07:48.639 --> 00:07:53.879 compare and as you correctly pointed out 00:07:51.360 --> 00:07:56.639 this this this uh this thing here 00:07:53.879 --> 00:07:58.120 therefore requires that you you sort of 00:07:56.639 --> 00:08:00.319 think about what the exchange rate is 00:07:58.120 --> 00:08:03.800 likely to be tomorrow so for example in 00:08:00.319 --> 00:08:07.158 my example here when I said suppose I is 00:08:03.800 --> 00:08:09.158 5% and I star interest rate in UK bone 00:08:07.158 --> 00:08:12.038 is 10% is it obvious that they should 00:08:09.158 --> 00:08:14.360 invest in the in the UK Bond and the 00:08:12.038 --> 00:08:16.000 answer is no not so fast because I know 00:08:14.360 --> 00:08:18.080 I'm going to make 5% more in terms of 00:08:16.000 --> 00:08:19.959 the return of the bond but then when I 00:08:18.079 --> 00:08:22.598 convert it back to Dollar I may lose all 00:08:19.959 --> 00:08:25.638 that gain because the the the the pound 00:08:22.598 --> 00:08:27.439 has depreciated visis the dollar in 00:08:25.639 --> 00:08:30.079 particular if the pound I expect the 00:08:27.439 --> 00:08:32.559 pound to depreciate Rel to or if I 00:08:30.079 --> 00:08:35.079 expect the dollar to appreciate relative 00:08:32.559 --> 00:08:38.319 to the pound by 5% then I'm 00:08:35.080 --> 00:08:40.839 indifferent yeah in one case I get 00:08:38.320 --> 00:08:44.440 because if I go the the US Bond route I 00:08:40.839 --> 00:08:48.399 get five 5% next year from this year to 00:08:44.440 --> 00:08:50.959 next if I go the UK bone route I get 10% 00:08:48.399 --> 00:08:53.360 in return in the bond minus 5% in the 00:08:50.958 --> 00:08:55.399 capital loss due to the the the 00:08:53.360 --> 00:08:58.639 appreciation of the dollar so on net I 00:08:55.399 --> 00:09:00.078 get 5% as well that's what appears here 00:08:58.639 --> 00:09:02.078 that's what I've done here here so what 00:09:00.078 --> 00:09:03.799 I did here is say you know if the 00:09:02.078 --> 00:09:06.199 markets are very integrated and they 00:09:03.799 --> 00:09:08.559 function fairly well those two returns 00:09:06.200 --> 00:09:10.278 should be more or less similar in 00:09:08.559 --> 00:09:12.039 equilibrium because prices are going to 00:09:10.278 --> 00:09:15.639 adjust exchanges are going to adjust and 00:09:12.039 --> 00:09:17.559 so on so these two ways of investing are 00:09:15.639 --> 00:09:18.919 more or less the same I'm going to take 00:09:17.559 --> 00:09:20.359 the stream assumption that they are 00:09:18.919 --> 00:09:23.199 exactly the same 00:09:20.360 --> 00:09:24.959 here so that this holds that the 00:09:23.200 --> 00:09:26.720 equilibrium we have to find that 00:09:24.958 --> 00:09:29.078 equilibrium these two things are going 00:09:26.720 --> 00:09:30.800 to be equal that's called and it's a 00:09:29.078 --> 00:09:34.000 very important Concept in international 00:09:30.799 --> 00:09:36.479 finance the uncover inp parity condition 00:09:34.000 --> 00:09:39.759 don't ask me why it's uncover but it's 00:09:36.480 --> 00:09:41.639 it's the inp parity condition and and 00:09:39.759 --> 00:09:45.720 again that one in particular is called 00:09:41.639 --> 00:09:47.559 the uncover interp condition if you do a 00:09:45.720 --> 00:09:49.200 little bit of and this just tells you 00:09:47.559 --> 00:09:52.159 that in equilibrium you have to be more 00:09:49.200 --> 00:09:55.399 be indifferent between investing to in 00:09:52.159 --> 00:09:57.039 one bone or the other okay if you do a 00:09:55.399 --> 00:09:58.759 little algebra here of the kind of we 00:09:57.039 --> 00:10:03.319 have done in the past like you know 1 00:09:58.759 --> 00:10:03.319 plus I is I is approximately equal to 00:10:04.200 --> 00:10:11.079 one is approximately equal to 1 over 1 00:10:07.078 --> 00:10:14.159 minus I or or this one 1 plus I star is 00:10:11.078 --> 00:10:15.919 approximately equal to one over 1 minus 00:10:14.159 --> 00:10:19.159 I star and so on that's that kind of 00:10:15.919 --> 00:10:22.360 approximation tailor expansion when when 00:10:19.159 --> 00:10:24.919 these terms are small then you can write 00:10:22.360 --> 00:10:27.919 this as this expression 00:10:24.919 --> 00:10:30.078 here okay and this says exactly what I 00:10:27.919 --> 00:10:34.078 just said in words this says 00:10:30.078 --> 00:10:36.879 look if the interest rate in the US bond 00:10:34.078 --> 00:10:42.039 is lower than 00:10:36.879 --> 00:10:44.240 the than the UK bonds interest rate 00:10:42.039 --> 00:10:45.958 that's okay in the sense that we can be 00:10:44.240 --> 00:10:48.240 different between these two things as 00:10:45.958 --> 00:10:49.638 long as you're expecting a depre an 00:10:48.240 --> 00:10:52.360 appreciation of the 00:10:49.639 --> 00:10:54.919 dollar that is equivalent to the 00:10:52.360 --> 00:10:56.959 difference in this two interest rate 00:10:54.919 --> 00:10:59.559 okay so that's what's called the 00:10:56.958 --> 00:11:01.000 interest parity condition the two in 00:10:59.559 --> 00:11:03.838 equilibrium the two are going to be the 00:11:01.000 --> 00:11:05.679 same once you adjust for the expected 00:11:03.839 --> 00:11:09.600 appreciation or depreciation of the 00:11:05.679 --> 00:11:13.000 currency okay so in my example before we 00:11:09.600 --> 00:11:15.399 had this interest rate with 5% that was 00:11:13.000 --> 00:11:17.879 10% then the only way that will that's 00:11:15.399 --> 00:11:21.600 going to be an equilibrium is that if we 00:11:17.879 --> 00:11:24.679 also expect the dollar to appreciate by 00:11:21.600 --> 00:11:28.720 5% okay so dollar appreciation remember 00:11:24.679 --> 00:11:32.120 is this guy going up so if this is 5% 00:11:28.720 --> 00:11:33.600 then it's fine to have 5% here 10% there 00:11:32.120 --> 00:11:36.839 because they both gave me the same 00:11:33.600 --> 00:11:38.480 return in expectation at least okay if I 00:11:36.839 --> 00:11:41.440 do it in dollars I say I'm going to get 00:11:38.480 --> 00:11:44.159 5% either way invest in direct in 00:11:41.440 --> 00:11:46.279 dollars or through the UK pound because 00:11:44.159 --> 00:11:48.639 in the in the UK bone in the UK bone I'm 00:11:46.278 --> 00:11:51.159 going to get 10% and then lose 5% 00:11:48.639 --> 00:11:53.519 because of the of the currency or I can 00:11:51.159 --> 00:11:55.838 do the comparison in pounds and and then 00:11:53.519 --> 00:11:58.720 I say well I'm going to get 10% in 00:11:55.839 --> 00:12:00.519 pounds directly and if I go the US way 00:11:58.720 --> 00:12:02.879 I'm going to get 5% but I'm going to get 00:12:00.519 --> 00:12:06.639 also 5% in the currency appreciation and 00:12:02.879 --> 00:12:08.958 that gives me 10% okay key concept 00:12:06.639 --> 00:12:11.519 anyways so these are the two senses of 00:12:08.958 --> 00:12:13.919 opening that we can have opening in in 00:12:11.519 --> 00:12:16.839 Goods Market opening in financial 00:12:13.919 --> 00:12:19.879 markets and the the the key relative 00:12:16.839 --> 00:12:23.160 prices and and things are going to 00:12:19.879 --> 00:12:25.078 equilibrate both markets one is the real 00:12:23.159 --> 00:12:28.480 exchange rate in the Goods Market in 00:12:25.078 --> 00:12:30.519 this one is the uncovering transparity 00:12:28.480 --> 00:12:33.839 condition I want to shut down this part 00:12:30.519 --> 00:12:35.919 of openness H for a lecture or so and 00:12:33.839 --> 00:12:38.320 I'm going to focus now on the on the 00:12:35.919 --> 00:12:40.198 Goods Market open opening only okay and 00:12:38.320 --> 00:12:43.079 then I'm going to come back to this but 00:12:40.198 --> 00:12:46.759 I just wanted to show you the two senses 00:12:43.078 --> 00:12:49.679 of opening okay so now let's forget a 00:12:46.759 --> 00:12:53.039 little bit about financial opening and 00:12:49.679 --> 00:12:55.759 and uh and let's just focus on opening 00:12:53.039 --> 00:12:57.198 the goods markets to International Trade 00:12:55.759 --> 00:12:59.639 okay so that means we're going to have 00:12:57.198 --> 00:13:02.599 now imports and exports floating around 00:12:59.639 --> 00:13:05.799 so this is we go back again to our aslm 00:13:02.600 --> 00:13:07.839 mod H to actually want to go back to our 00:13:05.799 --> 00:13:09.639 Goods Market only mod the very first 00:13:07.839 --> 00:13:11.800 model we saw in this course but we're 00:13:09.639 --> 00:13:16.399 going to bring back a couple of terms 00:13:11.799 --> 00:13:17.879 that we shut down there okay now 00:13:16.399 --> 00:13:19.399 something that will be that we didn't 00:13:17.879 --> 00:13:22.399 need to worry about but we're going to 00:13:19.399 --> 00:13:23.759 have to worry about here a lot is that 00:13:22.399 --> 00:13:26.639 there is a distinction between the 00:13:23.759 --> 00:13:29.278 demand for domestic goods and the 00:13:26.639 --> 00:13:31.799 domestic demand for goods 00:13:29.278 --> 00:13:33.679 okay I know this going to be tricky but 00:13:31.799 --> 00:13:36.278 but okay there's a difference between 00:13:33.679 --> 00:13:39.120 demand for domestic Goods versus the 00:13:36.278 --> 00:13:42.480 domestic demand for goods this is what 00:13:39.120 --> 00:13:46.000 residents us say us residents household 00:13:42.480 --> 00:13:49.800 firms government demand in terms of 00:13:46.000 --> 00:13:51.519 goods this is how those same agents plus 00:13:49.799 --> 00:13:54.078 the rest of the world demand of 00:13:51.519 --> 00:13:56.159 domestically produced Goods that's the 00:13:54.078 --> 00:13:59.439 distinction when the economy was closed 00:13:56.159 --> 00:14:03.120 they were the same but now they're not 00:13:59.440 --> 00:14:06.240 okay so the domestic demand Remains the 00:14:03.120 --> 00:14:08.278 Same as before okay domestic demand is 00:14:06.240 --> 00:14:12.879 whatever the households demand 00:14:08.278 --> 00:14:14.879 consumption plus firm's investment plus 00:14:12.879 --> 00:14:18.000 government expenditure that's the same 00:14:14.879 --> 00:14:19.838 we had in close economy this hasn't 00:14:18.000 --> 00:14:21.879 changed the domestic demand is the same 00:14:19.839 --> 00:14:24.440 is a function of the same behavioral 00:14:21.879 --> 00:14:26.000 functions that we had there and the only 00:14:24.440 --> 00:14:28.079 behavioral function that was in the only 00:14:26.000 --> 00:14:29.600 two that we had was the consumption 00:14:28.078 --> 00:14:30.958 function and investment function 00:14:29.600 --> 00:14:33.920 remember so That Remains the Same 00:14:30.958 --> 00:14:36.679 nothing has changed what does change is 00:14:33.919 --> 00:14:38.360 that this is no longer what determines 00:14:36.679 --> 00:14:40.599 the demand for domestically produced 00:14:38.360 --> 00:14:43.759 goods and remember that's very key in 00:14:40.600 --> 00:14:45.480 the short run because this is so Canan 00:14:43.759 --> 00:14:48.600 model with very sticky prices demand 00:14:45.480 --> 00:14:50.278 determines output activity so if we're 00:14:48.600 --> 00:14:52.680 going to determine domestic production 00:14:50.278 --> 00:14:54.399 from demand we better be very careful 00:14:52.679 --> 00:14:57.078 about what is the demand for 00:14:54.399 --> 00:14:58.799 domestically produced Goods this is 00:14:57.078 --> 00:15:00.799 demand for both domestically produced 00:14:58.799 --> 00:15:02.399 good and foreign produced Goods some of 00:15:00.799 --> 00:15:04.719 those demand will be satisfied by 00:15:02.399 --> 00:15:06.440 Imports that's not demand for domestic 00:15:04.720 --> 00:15:08.800 production and therefore will not be 00:15:06.440 --> 00:15:11.120 determined equilibrium output 00:15:08.799 --> 00:15:13.758 domestically okay so this is going to be 00:15:11.120 --> 00:15:16.440 the New Concept which is demand for 00:15:13.759 --> 00:15:19.240 domestic goods and demand for domestic 00:15:16.440 --> 00:15:21.759 Goods is the same as demand as domestic 00:15:19.240 --> 00:15:24.480 demand for goods that the thing we had 00:15:21.759 --> 00:15:26.639 in close economy minus that part of 00:15:24.480 --> 00:15:28.600 demand that is Satisfied by Imports so 00:15:26.639 --> 00:15:30.480 minus Imports and divided by The 00:15:28.600 --> 00:15:32.040 Exchange because inputs may be priced in 00:15:30.480 --> 00:15:33.839 euros say and I have to convert them 00:15:32.039 --> 00:15:36.278 into dollars that's the reason very 00:15:33.839 --> 00:15:40.519 exchange don't worry about this for now 00:15:36.278 --> 00:15:44.639 okay so I had to subtract from that 00:15:40.519 --> 00:15:47.959 Imports because that's Demand by 00:15:44.639 --> 00:15:50.039 Resident us resident that doesn't go to 00:15:47.958 --> 00:15:52.638 demand to demand for domestically 00:15:50.039 --> 00:15:54.679 produced Goods it's demand for BMWs 00:15:52.639 --> 00:15:57.480 whatever so that's not going to affect 00:15:54.679 --> 00:15:58.479 the demand for Ford good cars and 00:15:57.480 --> 00:16:00.399 therefore it will not affect the 00:15:58.480 --> 00:16:04.039 production of four 00:16:00.399 --> 00:16:07.399 cars because it's not demand for that 00:16:04.039 --> 00:16:09.078 but against that we also have the demand 00:16:07.399 --> 00:16:11.159 a component of demand for domestically 00:16:09.078 --> 00:16:14.439 produced good that we didn't have before 00:16:11.159 --> 00:16:18.159 which is what foreigners demand from the 00:16:14.440 --> 00:16:21.319 US okay part of the demand that probably 00:16:18.159 --> 00:16:24.240 not for a lot at least part of the the 00:16:21.318 --> 00:16:27.519 demand that us 00:16:24.240 --> 00:16:30.039 Goods perceived us production perceived 00:16:27.519 --> 00:16:33.078 is not due to resident is due to 00:16:30.039 --> 00:16:36.360 foreigners that are importing us Goods 00:16:33.078 --> 00:16:37.559 okay Apple s sells a lot of phones to 00:16:36.360 --> 00:16:40.360 the rest of the 00:16:37.559 --> 00:16:42.479 world okay that's determined by Foreign 00:16:40.360 --> 00:16:46.318 demand for domestically produced good 00:16:42.480 --> 00:16:50.079 that's what we want to call X exports 00:16:46.318 --> 00:16:53.078 okay so this is our new key concept here 00:16:50.078 --> 00:16:55.120 Z okay which is the same as what we used 00:16:53.078 --> 00:16:58.919 to have but now we need to understand 00:16:55.120 --> 00:17:02.039 two more terms the export and it ask 00:16:58.919 --> 00:17:04.159 going to be a function and import which 00:17:02.039 --> 00:17:07.759 also will be a function so let me 00:17:04.160 --> 00:17:11.120 introduce that so exports we're going to 00:17:07.759 --> 00:17:13.000 assume simplify things but it's sensible 00:17:11.119 --> 00:17:15.438 behavioral assumption we're going to 00:17:13.000 --> 00:17:18.880 assume that exports are increasing in 00:17:15.439 --> 00:17:22.199 foreign output that's what y star 00:17:18.880 --> 00:17:24.880 means and it makes sense is the rest of 00:17:22.199 --> 00:17:27.400 the world I mean Emerging Market the 00:17:24.880 --> 00:17:30.760 commodity producing economies today are 00:17:27.400 --> 00:17:33.600 very excited about the recover in China 00:17:30.759 --> 00:17:36.079 no China is reopening so so it's a big 00:17:33.599 --> 00:17:37.879 boom domestically that's great news for 00:17:36.079 --> 00:17:40.079 the Emerging Markets commodity producers 00:17:37.880 --> 00:17:42.440 because that will increase the demand 00:17:40.079 --> 00:17:44.159 from China for goods produced around the 00:17:42.440 --> 00:17:47.200 world in particular in commodity 00:17:44.160 --> 00:17:49.558 producing economies so so that's what 00:17:47.200 --> 00:17:51.840 this is capturing if if an important 00:17:49.558 --> 00:17:53.480 trading partners output goes up income 00:17:51.839 --> 00:17:55.439 goes up then they're they're going to 00:17:53.480 --> 00:17:56.880 consume everything they're domestic 00:17:55.440 --> 00:17:59.080 Goods but they're also going to consume 00:17:56.880 --> 00:18:01.039 the goods they import which are our 00:17:59.079 --> 00:18:02.359 exports okay so that's the reason this 00:18:01.038 --> 00:18:06.640 is 00:18:02.359 --> 00:18:08.038 increasing ER exports are decreasing on 00:18:06.640 --> 00:18:10.759 the real exchange 00:18:08.038 --> 00:18:12.960 rate that's sensible assumption why why 00:18:10.759 --> 00:18:15.759 do you think it's a sensible assumption 00:18:12.960 --> 00:18:19.720 so why do you think that exports US 00:18:15.759 --> 00:18:23.480 exports are decreasing on the real 00:18:19.720 --> 00:18:23.480 exchange rate 00:18:26.279 --> 00:18:32.279 Epsilon for for foreign customers to BU 00:18:30.000 --> 00:18:34.558 exactly because then us Goods become 00:18:32.279 --> 00:18:36.119 more expensive relative to foreign Goods 00:18:34.558 --> 00:18:39.319 that's what a real exchange appreciation 00:18:36.119 --> 00:18:42.038 is and therefore there is L less demand 00:18:39.319 --> 00:18:43.839 for domestically for for us Goods okay 00:18:42.038 --> 00:18:48.480 that's that's the reason we have that 00:18:43.839 --> 00:18:51.240 time what about import well Imports are 00:18:48.480 --> 00:18:54.558 sort of the the Dual of that meaning of 00:18:51.240 --> 00:18:56.159 the export function is is is is H is 00:18:54.558 --> 00:18:59.240 actually our Imports is what the other 00:18:56.159 --> 00:19:02.280 countries sees as their export okay 00:18:59.240 --> 00:19:04.480 so our inputs will tend to go up when 00:19:02.279 --> 00:19:07.440 domestic output goes up because if 00:19:04.480 --> 00:19:10.360 domestic income goes up domestic 00:19:07.440 --> 00:19:12.519 consumer say will both consume more 00:19:10.359 --> 00:19:15.199 Goods at home but they will also consume 00:19:12.519 --> 00:19:17.038 more Goods abroad no they going to scale 00:19:15.200 --> 00:19:19.840 up their consumption and they're going 00:19:17.038 --> 00:19:20.798 to consume consume from from both places 00:19:19.839 --> 00:19:23.038 so 00:19:20.798 --> 00:19:25.240 Imports H will is an increaseing 00:19:23.038 --> 00:19:27.759 function of domestic 00:19:25.240 --> 00:19:31.038 output what about the the real exchange 00:19:27.759 --> 00:19:36.000 rate here well inputs are an increasing 00:19:31.038 --> 00:19:38.319 function of the um real exchange rate 00:19:36.000 --> 00:19:38.319 why is 00:19:40.919 --> 00:19:46.280 that it's the same argument of export 00:19:43.400 --> 00:19:46.280 but seem from the other 00:19:49.400 --> 00:19:54.880 side remember when why do we use this 00:19:52.880 --> 00:19:57.720 Epsilon 4 to decide where do we want to 00:19:54.880 --> 00:20:00.640 buy our Goods if Epsilon goes up means 00:19:57.720 --> 00:20:03.038 our Goods become more 00:20:00.640 --> 00:20:05.200 expensive if our Goods become more 00:20:03.038 --> 00:20:06.200 expensive for any given level of 00:20:05.200 --> 00:20:08.000 domestic 00:20:06.200 --> 00:20:11.440 consumption where do you think you'll 00:20:08.000 --> 00:20:14.359 buy your goods you'll buy more abroad 00:20:11.440 --> 00:20:17.320 are cheaper okay so then that's an 00:20:14.359 --> 00:20:19.519 increasing function of NS 00:20:17.319 --> 00:20:20.759 good any question about that because 00:20:19.519 --> 00:20:22.279 these are the only sort of new 00:20:20.759 --> 00:20:25.240 behavioral equations we're going to have 00:20:22.279 --> 00:20:28.119 for for this 00:20:25.240 --> 00:20:29.519 model and and what I'm going to do next 00:20:28.119 --> 00:20:32.399 is I'm going to start from the same 00:20:29.519 --> 00:20:36.359 model we had in in in I don't know 00:20:32.400 --> 00:20:39.360 lecture two or three h and uh I'm going 00:20:36.359 --> 00:20:42.119 to I'm going to add this these terms and 00:20:39.359 --> 00:20:46.240 see how things change 00:20:42.119 --> 00:20:48.399 okay okay good so let's do 00:20:46.240 --> 00:20:52.079 that so 00:20:48.400 --> 00:20:54.798 remember H I think the first curve that 00:20:52.079 --> 00:20:57.599 would the the first the very first 00:20:54.798 --> 00:21:01.839 diagram we had in this class was this 00:20:57.599 --> 00:21:05.199 one this was just a demand for domestic 00:21:01.839 --> 00:21:07.359 uh domestic demand sorry which was just 00:21:05.200 --> 00:21:10.319 C plus I plus G it's an increasing 00:21:07.359 --> 00:21:12.558 function here because consumption and 00:21:10.319 --> 00:21:15.678 investment are increasing function of 00:21:12.558 --> 00:21:18.158 output okay and then in close economy 00:21:15.679 --> 00:21:20.360 what we did is we had a 45 degree line 00:21:18.159 --> 00:21:22.480 here and we said in equilibrium output 00:21:20.359 --> 00:21:24.678 equal to demand and therefore the 00:21:22.480 --> 00:21:27.240 intersection of this curve with the 45 00:21:24.679 --> 00:21:29.038 45 degree line gave us our equilibrium 00:21:27.240 --> 00:21:31.038 output that's what we have 00:21:29.038 --> 00:21:32.919 we need to change things a little bit 00:21:31.038 --> 00:21:37.558 we're going to put the 45 degree line in 00:21:32.919 --> 00:21:39.400 the next slide but we first need to this 00:21:37.558 --> 00:21:40.960 is not the relevant demand for 00:21:39.400 --> 00:21:44.080 domestically produced Goods so we need 00:21:40.960 --> 00:21:47.278 to go from here to the demand that is 00:21:44.079 --> 00:21:49.558 relevant for domestic producers okay so 00:21:47.278 --> 00:21:52.200 the first thing we need to do is we need 00:21:49.558 --> 00:21:54.319 to subtract Imports because part of the 00:21:52.200 --> 00:21:58.080 demand will go for foreign 00:21:54.319 --> 00:21:59.158 Goods okay and so that's what I'm doing 00:21:58.079 --> 00:22:01.720 here 00:21:59.159 --> 00:22:05.000 to this domestic demand I'm subract 00:22:01.720 --> 00:22:07.519 subtracting the part that H that is 00:22:05.000 --> 00:22:08.960 going to foreign Goods not domestic 00:22:07.519 --> 00:22:11.839 Goods because this is not demand for 00:22:08.960 --> 00:22:13.840 domestically produced Goods so obviously 00:22:11.839 --> 00:22:15.439 this is a shift down but there is also 00:22:13.839 --> 00:22:18.399 rotation why is 00:22:15.440 --> 00:22:21.519 that you see obviously we're subtracting 00:22:18.400 --> 00:22:23.880 imports from domestic demand so that 00:22:21.519 --> 00:22:25.440 moves us down here but it's also it's 00:22:23.880 --> 00:22:30.278 not a parallel 00:22:25.440 --> 00:22:30.278 shift this curve becomes flatter 00:22:30.558 --> 00:22:35.278 why is that in other words the decline 00:22:33.240 --> 00:22:37.599 is larger for the different the Gap is 00:22:35.278 --> 00:22:39.919 larger for high levels of income than 00:22:37.599 --> 00:22:40.719 for low levels of income or output why 00:22:39.919 --> 00:22:45.559 is 00:22:40.720 --> 00:22:47.600 that depend on outut exactly is because 00:22:45.558 --> 00:22:51.038 there's a positive marginal propensity 00:22:47.599 --> 00:22:53.240 to import and so you'll import more if 00:22:51.038 --> 00:22:57.000 output is higher okay and that's the 00:22:53.240 --> 00:22:59.240 reason we have this C notice that this 00:22:57.000 --> 00:23:01.759 also means well let me get to the end of 00:22:59.240 --> 00:23:04.558 that and and of these diagrams and then 00:23:01.759 --> 00:23:07.400 I'll get back to this so one step more 00:23:04.558 --> 00:23:10.158 still this is not what I need to 00:23:07.400 --> 00:23:11.600 integrate with my 45 degree line because 00:23:10.159 --> 00:23:14.720 this is not the demand that domestic 00:23:11.599 --> 00:23:16.359 producer will face we still have to add 00:23:14.720 --> 00:23:19.880 the demand that comes from 00:23:16.359 --> 00:23:24.119 foreigners and that's exports okay so to 00:23:19.880 --> 00:23:26.000 this AA function I have to add exports 00:23:24.119 --> 00:23:28.038 and exports is a parallel shift because 00:23:26.000 --> 00:23:29.558 it didn't depend on domestic output it 00:23:28.038 --> 00:23:31.038 depend on foreign output so foreign 00:23:29.558 --> 00:23:33.720 output is going to be a parameter in 00:23:31.038 --> 00:23:35.679 this curve but it's not doesn't change 00:23:33.720 --> 00:23:40.000 the slope of that 00:23:35.679 --> 00:23:41.798 curve so here we went from the DD curve 00:23:40.000 --> 00:23:43.519 to the new curve which is the reant for 00:23:41.798 --> 00:23:48.558 equilibrium domestic equilibrium output 00:23:43.519 --> 00:23:52.000 which is this ZZ curve 00:23:48.558 --> 00:23:55.879 okay now notice two things or one thing 00:23:52.000 --> 00:23:58.640 about this ZZ curve relative to DD what 00:23:55.880 --> 00:24:01.559 is the most obvious 00:23:58.640 --> 00:24:01.559 difference between these two 00:24:03.319 --> 00:24:09.158 curves no this is the one we use in 00:24:06.400 --> 00:24:11.559 lecture two or three I don't know and 00:24:09.159 --> 00:24:12.880 then when we did slm and all that and 00:24:11.558 --> 00:24:15.038 this is the one we're going to use now 00:24:12.880 --> 00:24:15.039 the 00:24:15.519 --> 00:24:23.798 ZZ it's flatter yeah why is 00:24:20.480 --> 00:24:25.360 that flatter is slow a slope will mean 00:24:23.798 --> 00:24:27.720 lower 00:24:25.359 --> 00:24:30.199 multiplier why is the multiplier lower 00:24:27.720 --> 00:24:32.960 then you know open economy part of the 00:24:30.200 --> 00:24:35.360 Dem falls on for exactly because part of 00:24:32.960 --> 00:24:37.840 the remember the the way we got to the 00:24:35.359 --> 00:24:40.759 multiplier is that income went up 00:24:37.839 --> 00:24:42.639 consumption went up the that increased 00:24:40.759 --> 00:24:44.200 income again and so on so forth but if 00:24:42.640 --> 00:24:46.240 part of that increasing consumption is 00:24:44.200 --> 00:24:48.000 going to foreign Goods that's not 00:24:46.240 --> 00:24:49.399 reflected in demand for domestically 00:24:48.000 --> 00:24:52.519 produced goods and therefore there's 00:24:49.398 --> 00:24:54.398 less of a multiplier okay and that's one 00:24:52.519 --> 00:24:57.079 characteristic of the open economy is 00:24:54.398 --> 00:24:59.839 that the multipliers are 00:24:57.079 --> 00:25:02.319 smaller the distinction is that you 00:24:59.839 --> 00:25:05.359 don't see it here but we have more 00:25:02.319 --> 00:25:08.000 parameters in particular a very 00:25:05.359 --> 00:25:09.879 important parameter here is y star y 00:25:08.000 --> 00:25:13.119 star didn't we didn't worry about what 00:25:09.880 --> 00:25:15.720 was income in Germany when we look at 00:25:13.119 --> 00:25:18.038 the islm the close economy model now we 00:25:15.720 --> 00:25:21.240 worry about what the income of our main 00:25:18.038 --> 00:25:23.759 trading partners is so you there's an 00:25:21.240 --> 00:25:26.000 extra parameter there 00:25:23.759 --> 00:25:27.640 good now we still haven't found 00:25:26.000 --> 00:25:30.519 equilibrium output but there is a point 00:25:27.640 --> 00:25:32.600 that is already interes in here which is 00:25:30.519 --> 00:25:35.359 this 00:25:32.599 --> 00:25:38.319 one what do I know of this point well in 00:25:35.359 --> 00:25:40.599 this point domestic demand for goods is 00:25:38.319 --> 00:25:43.158 the same as demand for domestically 00:25:40.599 --> 00:25:46.278 produced goods for domestic goods and 00:25:43.159 --> 00:25:49.600 that also means that the trade balance 00:25:46.278 --> 00:25:51.919 is zero meaning that at that point 00:25:49.599 --> 00:25:55.759 exports is exactly equal to Imports so 00:25:51.919 --> 00:25:57.320 net exports are equal to zero okay so 00:25:55.759 --> 00:25:59.720 that's what I'm plotting here actually 00:25:57.319 --> 00:26:02.678 this is the net export function the net 00:25:59.720 --> 00:26:02.679 export function is 00:26:03.919 --> 00:26:09.679 simply that minus that divided by the 00:26:07.359 --> 00:26:10.839 exchange rate okay so that's what I'm 00:26:09.679 --> 00:26:13.640 plotting 00:26:10.839 --> 00:26:15.879 here is a decreasing function of output 00:26:13.640 --> 00:26:18.559 why is 00:26:15.880 --> 00:26:19.760 that why is this decreasing in in 00:26:18.558 --> 00:26:23.599 domestic 00:26:19.759 --> 00:26:26.079 output remember this is export minus 00:26:23.599 --> 00:26:29.879 UT divided by the exchanger but we're 00:26:26.079 --> 00:26:33.158 not moving the exchanger for now 00:26:29.880 --> 00:26:35.640 why is this decreasing that means here 00:26:33.159 --> 00:26:38.360 exports exceed Imports here Imports 00:26:35.640 --> 00:26:40.399 exceed exports so here you have a trade 00:26:38.359 --> 00:26:43.558 deficit here you have a trade surplus 00:26:40.398 --> 00:26:46.359 why why is that why is that the shape 00:26:43.558 --> 00:26:46.359 why is it downward 00:26:52.558 --> 00:26:58.639 SL import grow outp grows export exactly 00:26:57.000 --> 00:27:01.079 export is not a function of domestic 00:26:58.640 --> 00:27:03.799 output it's a function of foreign output 00:27:01.079 --> 00:27:06.918 while while inputs is an increasing 00:27:03.798 --> 00:27:10.119 function of domestic output a net export 00:27:06.919 --> 00:27:11.840 is exports minus Imports okay so that's 00:27:10.119 --> 00:27:13.439 what this is decreasing and this point 00:27:11.839 --> 00:27:15.079 here happens to be when the two things 00:27:13.440 --> 00:27:18.278 are exactly 00:27:15.079 --> 00:27:22.278 balance that's trade balance happens to 00:27:18.278 --> 00:27:23.599 be the point where DD is equal to ZZ 00:27:22.278 --> 00:27:24.919 that's just there's no reason why 00:27:23.599 --> 00:27:26.719 equilibrium output should be at that 00:27:24.919 --> 00:27:28.960 level I'm saying that's a point where 00:27:26.720 --> 00:27:31.919 that happens okay now we're going to 00:27:28.960 --> 00:27:33.399 find equilibrium output to find to find 00:27:31.919 --> 00:27:35.720 equilibrium output I'm going to erase 00:27:33.398 --> 00:27:38.359 all this extra curves here and I'm just 00:27:35.720 --> 00:27:40.319 going to keep the ZZ here because that's 00:27:38.359 --> 00:27:42.918 the demand for domestically produced 00:27:40.319 --> 00:27:45.720 goods and and I'm doing short run here 00:27:42.919 --> 00:27:48.038 so I know that domestic production is 00:27:45.720 --> 00:27:50.120 going that is the Y is going to be equal 00:27:48.038 --> 00:27:52.599 to demand for domestic Goods it's it's a 00:27:50.119 --> 00:27:56.439 demand determined model that's what the 00:27:52.599 --> 00:27:57.719 short run is all about so erase all this 00:27:56.440 --> 00:28:01.600 all these curves and I'm going to just 00:27:57.720 --> 00:28:05.919 keep this ZZ curve there there you 00:28:01.599 --> 00:28:07.798 are okay so now I have my 45 degree line 00:28:05.919 --> 00:28:10.559 because in the short 00:28:07.798 --> 00:28:13.319 run equilibrium output is equal to 00:28:10.558 --> 00:28:14.960 aggregate demand aggregate demand for 00:28:13.319 --> 00:28:18.119 what for domestically produced Goods 00:28:14.960 --> 00:28:20.319 that's the reason I'm using ZZ not DD 00:28:18.119 --> 00:28:22.359 okay but there you are then you do 00:28:20.319 --> 00:28:24.599 exactly the same as we did before boom 00:28:22.359 --> 00:28:26.879 that's our equilibrium outut and here 00:28:24.599 --> 00:28:27.918 you can do all sort of experiments and 00:28:26.880 --> 00:28:29.080 you're going to get the same sort of 00:28:27.919 --> 00:28:30.880 things things that we there the 00:28:29.079 --> 00:28:32.278 multiplier is a smaller multiplier but 00:28:30.880 --> 00:28:36.840 you're going to still get a multiplier 00:28:32.278 --> 00:28:40.640 and all these kind of things okay now I 00:28:36.839 --> 00:28:42.879 this is just I I I in this example it 00:28:40.640 --> 00:28:45.679 happens that at this equilibrium output 00:28:42.880 --> 00:28:48.320 this country has a trade deficit I just 00:28:45.679 --> 00:28:52.080 made up that 00:28:48.319 --> 00:28:55.839 okay so the so this is the equilibrium 00:28:52.079 --> 00:28:58.759 condition is output equal to Z output 00:28:55.839 --> 00:29:00.720 equal to then domestic demand plus 00:28:58.759 --> 00:29:03.879 export minus 00:29:00.720 --> 00:29:06.038 input okay and then the net export is 00:29:03.880 --> 00:29:09.360 just I'm plotting this term 00:29:06.038 --> 00:29:11.839 here that's what we have here but 00:29:09.359 --> 00:29:14.678 equilibrium is just y equal to Z it's 00:29:11.839 --> 00:29:18.839 not this equal to 00:29:14.679 --> 00:29:20.720 zero you can think about equilibrium but 00:29:18.839 --> 00:29:24.038 this is this is what it is given that 00:29:20.720 --> 00:29:24.038 that's equilibrium how 00:29:24.839 --> 00:29:28.839 okay is this clear I mean this is the 00:29:27.119 --> 00:29:32.439 start diagram of of this part of the 00:29:28.839 --> 00:29:32.439 course so you need to understand this 00:29:32.558 --> 00:29:37.918 diagram go over 00:29:35.240 --> 00:29:39.640 it play with it think what is a 00:29:37.919 --> 00:29:41.640 parameter in there and so I'm going to 00:29:39.640 --> 00:29:43.240 do a little bit of that now but make 00:29:41.640 --> 00:29:46.240 sure that you 00:29:43.240 --> 00:29:46.240 understand 00:29:47.599 --> 00:29:52.639 this okay so let a few things here so 00:29:50.798 --> 00:29:55.038 let's do things that we did in close 00:29:52.640 --> 00:29:56.759 economy so suppose that you have a f 00:29:55.038 --> 00:29:59.119 fiscal 00:29:56.759 --> 00:30:00.919 expansion so so what did we do when we 00:29:59.119 --> 00:30:04.479 had a fysal expansion in lecture two or 00:30:00.919 --> 00:30:06.919 three well that moves the ZZ curve up 00:30:04.480 --> 00:30:08.880 output will go up and then there will be 00:30:06.919 --> 00:30:11.000 a multiplier so output will go up by 00:30:08.880 --> 00:30:14.519 more than the initial increasing 00:30:11.000 --> 00:30:17.599 government expenditure no that's what we 00:30:14.519 --> 00:30:18.440 had before it will go up by more but not 00:30:17.599 --> 00:30:22.398 as 00:30:18.440 --> 00:30:24.200 much as it did in the close economy so 00:30:22.398 --> 00:30:25.879 the the increas in output will will be 00:30:24.200 --> 00:30:28.519 more than the increase in government 00:30:25.880 --> 00:30:31.480 expenditure but it will be not as much 00:30:28.519 --> 00:30:34.839 as it would have been had we had a close 00:30:31.480 --> 00:30:34.839 economy why is 00:30:39.960 --> 00:30:45.679 that why is the last part 00:30:43.359 --> 00:30:48.359 true why not as much as it would have 00:30:45.679 --> 00:30:48.360 been in the close 00:30:50.200 --> 00:30:55.639 economy well you can read it here is 00:30:53.278 --> 00:30:57.200 because part of that extra energy the 00:30:55.638 --> 00:30:59.879 man for consumption will go to foreign 00:30:57.200 --> 00:31:03.240 Goods it will not come back to demand 00:30:59.880 --> 00:31:05.240 more domestic production okay and that's 00:31:03.240 --> 00:31:07.000 reflected in that the trade deficit in 00:31:05.240 --> 00:31:09.759 this particular example we start with a 00:31:07.000 --> 00:31:12.200 situation where the the we had a the 00:31:09.759 --> 00:31:14.200 trade was balanced we had no net export 00:31:12.200 --> 00:31:15.080 was equal to zero and we end up with a 00:31:14.200 --> 00:31:17.720 trade 00:31:15.079 --> 00:31:19.439 deficit that trade deficit is exactly 00:31:17.720 --> 00:31:21.720 the same reason why we got a smaller 00:31:19.440 --> 00:31:23.519 multiply is because part of the extra 00:31:21.720 --> 00:31:25.639 demand that comes from the extra income 00:31:23.519 --> 00:31:28.079 that created by the additional 00:31:25.638 --> 00:31:30.759 expenditure H by the aggregate demand 00:31:28.079 --> 00:31:32.638 effect of additional expenditure went to 00:31:30.759 --> 00:31:35.638 the demand for foreign 00:31:32.638 --> 00:31:35.638 Goods 00:31:39.798 --> 00:31:45.960 okay good so do the same things we did 00:31:44.000 --> 00:31:48.038 in in close Eon just practice here 00:31:45.960 --> 00:31:49.759 increase taxes do things like that 00:31:48.038 --> 00:31:52.919 increase 00:31:49.759 --> 00:31:55.398 czo and see what happens both with 00:31:52.919 --> 00:31:56.759 equilibrium output qualitatively will be 00:31:55.398 --> 00:31:58.558 exactly the same as with you had in 00:31:56.759 --> 00:32:00.278 close economy except that the effects 00:31:58.558 --> 00:32:01.839 are going to be smaller but you're going 00:32:00.278 --> 00:32:06.519 to get something new which is what 00:32:01.839 --> 00:32:06.519 happens to the trade deficit as a result 00:32:06.599 --> 00:32:10.879 okay 00:32:08.440 --> 00:32:13.080 so this is a shock we couldn't do in the 00:32:10.880 --> 00:32:15.440 close economy case which is what happens 00:32:13.079 --> 00:32:18.199 if foreign demand go comes up that's 00:32:15.440 --> 00:32:20.360 what I'm saying everyone is jubilant in 00:32:18.200 --> 00:32:23.240 Emerging Market worlds because 00:32:20.359 --> 00:32:25.759 China's output is going 00:32:23.240 --> 00:32:28.519 up so what are all these economists 00:32:25.759 --> 00:32:29.798 thinking say well China's output is 00:32:28.519 --> 00:32:31.519 going up that means they're going to 00:32:29.798 --> 00:32:35.558 import a lot more from 00:32:31.519 --> 00:32:37.558 us okay that is they think our exports 00:32:35.558 --> 00:32:40.119 are going to go up because 00:32:37.558 --> 00:32:45.599 Chinese consumption is going 00:32:40.119 --> 00:32:47.918 up well exports going up means up that 00:32:45.599 --> 00:32:51.359 our ZZ curve moves 00:32:47.919 --> 00:32:53.440 up okay so then what do you get well you 00:32:51.359 --> 00:32:56.398 get 00:32:53.440 --> 00:32:59.159 er now an increas in in 00:32:56.398 --> 00:33:01.000 exports uh for any given level of income 00:32:59.159 --> 00:33:02.720 means that eventually you you're going 00:33:01.000 --> 00:33:04.558 to get higher output immediately but 00:33:02.720 --> 00:33:06.600 higher output also has a multiplier 00:33:04.558 --> 00:33:08.359 although smaller but at the end of the 00:33:06.599 --> 00:33:10.278 day you're going to get higher 00:33:08.359 --> 00:33:11.719 equilibrium out so it's great news 00:33:10.278 --> 00:33:13.240 that's the reason they're so happy it's 00:33:11.720 --> 00:33:16.038 great news that China is expanding 00:33:13.240 --> 00:33:18.440 because it's also lead to an expansion 00:33:16.038 --> 00:33:22.599 in h the rest of the 00:33:18.440 --> 00:33:26.200 world okay so that's what you 00:33:22.599 --> 00:33:28.439 get so that in that sense you know that 00:33:26.200 --> 00:33:31.480 if if if China decides to do an 00:33:28.440 --> 00:33:35.240 expansionary fiscal policy it also 00:33:31.480 --> 00:33:38.480 expands us output or even more important 00:33:35.240 --> 00:33:39.679 for Chilean output okay it does that so 00:33:38.480 --> 00:33:42.200 it's the 00:33:39.679 --> 00:33:44.559 same Chile could have done it by having 00:33:42.200 --> 00:33:47.720 their own fiscal policy that would also 00:33:44.558 --> 00:33:49.519 expanded output but it's wonderful that 00:33:47.720 --> 00:33:51.720 China decides to do it because that 00:33:49.519 --> 00:33:55.120 expands output as well with one 00:33:51.720 --> 00:33:57.440 advantage two advantages what is but 00:33:55.119 --> 00:33:58.518 there's one that you can see here which 00:33:57.440 --> 00:34:00.000 is what 00:33:58.519 --> 00:34:01.638 why is it that they prefer that China 00:34:00.000 --> 00:34:06.119 does the effort rather than 00:34:01.638 --> 00:34:06.119 me what looks better 00:34:07.398 --> 00:34:13.239 here assume they are comparable size and 00:34:10.320 --> 00:34:15.599 so on in terms of the impact in the in 00:34:13.239 --> 00:34:17.878 the top diagram supposed to generate the 00:34:15.599 --> 00:34:20.039 same increasing output as a result of 00:34:17.878 --> 00:34:22.358 one policy which is my domestic 00:34:20.039 --> 00:34:25.358 expansion in G which is what we did the 00:34:22.358 --> 00:34:29.000 previous slide or because China's goes 00:34:25.358 --> 00:34:30.679 into a boom and starts importing a lot 00:34:29.000 --> 00:34:33.039 that's this we can we can export a lot 00:34:30.679 --> 00:34:35.599 to them so suppose we get the same 00:34:33.039 --> 00:34:38.039 increase in output what looks a little 00:34:35.599 --> 00:34:39.119 better not a little better it can look a 00:34:38.039 --> 00:34:41.480 lot 00:34:39.119 --> 00:34:42.599 better there are two things but one is 00:34:41.480 --> 00:34:45.559 in this 00:34:42.599 --> 00:34:47.119 diagram which is remember if I did go in 00:34:45.559 --> 00:34:49.358 expenditure the net export function 00:34:47.119 --> 00:34:52.119 wouldn't have moved and I ended up with 00:34:49.358 --> 00:34:53.918 higher output I would have ended up with 00:34:52.119 --> 00:34:58.039 a bigger trade 00:34:53.918 --> 00:35:00.440 deficit okay in this case it's export 00:34:58.039 --> 00:35:02.960 driven so it's the opposite because the 00:35:00.440 --> 00:35:05.800 now the net export function is Shifting 00:35:02.960 --> 00:35:08.079 up you know if I move y star up I'm 00:35:05.800 --> 00:35:11.200 moving export up that means the net 00:35:08.079 --> 00:35:13.200 export function is moving up shifting up 00:35:11.199 --> 00:35:14.838 and then I'm losing some of that because 00:35:13.199 --> 00:35:19.118 in increasing domestic 00:35:14.838 --> 00:35:21.519 output er um goes into input but at the 00:35:19.119 --> 00:35:25.720 end of the day in this case I end up 00:35:21.519 --> 00:35:28.199 with a trade surplus rather than a trade 00:35:25.719 --> 00:35:30.879 deficit okay so lots of things that's 00:35:28.199 --> 00:35:32.399 the reason when you open the world 00:35:30.880 --> 00:35:33.800 there's a lot of free writing here you 00:35:32.400 --> 00:35:36.000 want the other one to do the policies 00:35:33.800 --> 00:35:37.560 for you because then then you're a lot 00:35:36.000 --> 00:35:39.559 better you can get the same increase in 00:35:37.559 --> 00:35:42.519 output but here you end up with a trade 00:35:39.559 --> 00:35:43.799 surplus rather than a trade deficit and 00:35:42.519 --> 00:35:45.159 there's a second thing that I'm not 00:35:43.800 --> 00:35:46.560 showing you here there's a big 00:35:45.159 --> 00:35:48.239 difference between you doing it you 00:35:46.559 --> 00:35:50.000 domestically by increasing government 00:35:48.239 --> 00:35:52.719 expenditure versus the other one doing 00:35:50.000 --> 00:35:55.039 it for you and they're pulling you 00:35:52.719 --> 00:35:57.919 through export what else will look 00:35:55.039 --> 00:36:00.440 better in the US in this case relative 00:35:57.920 --> 00:36:00.440 to the previous 00:36:01.519 --> 00:36:04.679 slide that's but that's too 00:36:03.280 --> 00:36:07.200 sophisticated we're still keeping the 00:36:04.679 --> 00:36:07.199 interest rate 00:36:08.239 --> 00:36:12.358 constant 00:36:09.760 --> 00:36:14.560 H that's even more sophisticated this is 00:36:12.358 --> 00:36:17.119 short run completely sticky prices 00:36:14.559 --> 00:36:17.119 forget all 00:36:22.679 --> 00:36:29.919 that fiscal deficits in the other one I 00:36:26.838 --> 00:36:32.239 need to increase G so they had a fiscal 00:36:29.920 --> 00:36:35.079 deficit here I don't need to do that and 00:36:32.239 --> 00:36:37.559 in fact in reality taxes are typically 00:36:35.079 --> 00:36:39.400 indexed to Output domestic output so 00:36:37.559 --> 00:36:42.358 that that probably will improve the 00:36:39.400 --> 00:36:44.559 deficit in the US 00:36:42.358 --> 00:36:48.358 okay so 00:36:44.559 --> 00:36:50.318 anyways the last point I want to H talk 00:36:48.358 --> 00:36:53.078 about is another variable that we didn't 00:36:50.318 --> 00:36:55.039 have in in the close economy which is 00:36:53.079 --> 00:36:58.119 the role for the exchange rate what the 00:36:55.039 --> 00:37:00.679 exchange rate can do and so for this we 00:36:58.119 --> 00:37:02.599 need to look you know the only term that 00:37:00.679 --> 00:37:05.799 depends on the exchange rate is this net 00:37:02.599 --> 00:37:07.880 export term no the exports minus inputs 00:37:05.800 --> 00:37:10.400 so what you know from net exports it's 00:37:07.880 --> 00:37:12.880 very clear what happens to net exports 00:37:10.400 --> 00:37:15.000 when we increase y star we did an 00:37:12.880 --> 00:37:18.200 experiment before that's what increase 00:37:15.000 --> 00:37:21.039 exports so net exports will increase if 00:37:18.199 --> 00:37:23.358 you increase y star we also know that 00:37:21.039 --> 00:37:26.880 net exports will decrease if domestic 00:37:23.358 --> 00:37:28.279 output goes up because inputs increase 00:37:26.880 --> 00:37:31.358 but from this expression is a little 00:37:28.280 --> 00:37:34.560 ambiguous what happens to net exports 00:37:31.358 --> 00:37:37.199 when there's a when the real exchange it 00:37:34.559 --> 00:37:39.000 appreciates and it's a little it's a 00:37:37.199 --> 00:37:42.318 little ambigous for the following 00:37:39.000 --> 00:37:45.400 reason the volume 00:37:42.318 --> 00:37:48.000 expression is clearly increasing in the 00:37:45.400 --> 00:37:50.119 real exchange if us Goods become more 00:37:48.000 --> 00:37:53.000 expensive you want to import more that's 00:37:50.119 --> 00:37:54.480 what we discussed before but the value 00:37:53.000 --> 00:37:56.960 may not be such because if you're 00:37:54.480 --> 00:37:58.960 importing those goods in euros and now 00:37:56.960 --> 00:38:01.119 the euro is cheaper for you then then 00:37:58.960 --> 00:38:04.318 you may you're are paying less for each 00:38:01.119 --> 00:38:06.160 unit you import okay now we're going to 00:38:04.318 --> 00:38:08.279 assume from now on that this second 00:38:06.159 --> 00:38:09.799 effect is not as strong as the volume 00:38:08.280 --> 00:38:11.880 effect and that's a very realistic 00:38:09.800 --> 00:38:14.800 assumption except for the very very very 00:38:11.880 --> 00:38:16.920 short run okay so that's going to be our 00:38:14.800 --> 00:38:20.839 assumption our assumption will be that 00:38:16.920 --> 00:38:23.318 net exports decrease when the currency 00:38:20.838 --> 00:38:25.838 appreciates if your goods become more 00:38:23.318 --> 00:38:27.960 expensive then on net you're going to 00:38:25.838 --> 00:38:30.440 have less net exports 00:38:27.960 --> 00:38:32.920 okay as an assumption it simply says 00:38:30.440 --> 00:38:34.920 that this guy in the numerator responds 00:38:32.920 --> 00:38:38.519 more strongly than the denominator to a 00:38:34.920 --> 00:38:41.318 depreciation to an appreciation of the 00:38:38.519 --> 00:38:44.559 exchange so the quantity effect is much 00:38:41.318 --> 00:38:44.559 more important than the price 00:38:44.960 --> 00:38:49.679 effect so again I'm not going to have 00:38:48.079 --> 00:38:51.680 trick questions about this or anything 00:38:49.679 --> 00:38:55.799 I'm going to assume that from now that's 00:38:51.679 --> 00:38:57.519 your assumption okay if I make a mistake 00:38:55.800 --> 00:38:59.599 and and I try to trick you in in the 00:38:57.519 --> 00:39:02.719 quiz for that you can charge me the 00:38:59.599 --> 00:39:05.880 points okay I don't intend to do that 00:39:02.719 --> 00:39:08.399 it's just IDE spot when one of the da 00:39:05.880 --> 00:39:11.760 sort of wrote something there and 00:39:08.400 --> 00:39:14.318 because this is the a very realistic 00:39:11.760 --> 00:39:16.640 assumption good so now let's see what 00:39:14.318 --> 00:39:20.920 happens then when the exchange rate 00:39:16.639 --> 00:39:22.078 moves and let me use it ER suppose that 00:39:20.920 --> 00:39:24.358 that you are in a situation where you 00:39:22.079 --> 00:39:27.839 want to reduce the trade 00:39:24.358 --> 00:39:29.318 deficit what would you do to so so the 00:39:27.838 --> 00:39:31.880 experiment I have here has two 00:39:29.318 --> 00:39:34.800 components but but let's talk about the 00:39:31.880 --> 00:39:36.440 first one suppose that that you your 00:39:34.800 --> 00:39:39.240 country has a big trade 00:39:36.440 --> 00:39:44.000 deficit H and you want to reduce 00:39:39.239 --> 00:39:47.679 that and the only tool you have is the 00:39:44.000 --> 00:39:47.679 exchange rate what would you 00:39:49.519 --> 00:39:54.880 do suppose you have trade deficit you 00:39:51.519 --> 00:39:59.318 don't like that and you can move the 00:39:54.880 --> 00:39:59.318 exchange rate around what would you do 00:40:00.280 --> 00:40:04.200 yes you depreciate you make the domestic 00:40:02.440 --> 00:40:08.000 Goods cheaper relative to the rest of 00:40:04.199 --> 00:40:10.000 the world so you depreciate H your 00:40:08.000 --> 00:40:13.440 currency which is the prices are 00:40:10.000 --> 00:40:15.480 completely sticky fixed than nominal 00:40:13.440 --> 00:40:17.440 depreciation means also real 00:40:15.480 --> 00:40:19.519 depreciation and that will increase 00:40:17.440 --> 00:40:22.720 increase net exports so what that will 00:40:19.519 --> 00:40:24.519 do if you depreciate so X The Exchange 00:40:22.719 --> 00:40:27.598 is also a parameter in this net export 00:40:24.519 --> 00:40:29.318 function and given my assumption when 00:40:27.599 --> 00:40:32.838 you depreciate the exchange rate then 00:40:29.318 --> 00:40:36.279 then moves the net export function up 00:40:32.838 --> 00:40:38.039 okay now the problem is that if you do 00:40:36.280 --> 00:40:41.240 that that's also going to be 00:40:38.039 --> 00:40:42.800 expansionary because now you know you 00:40:41.239 --> 00:40:44.519 had certain equilibrium level of output 00:40:42.800 --> 00:40:46.039 and now there's going to be expend 00:40:44.519 --> 00:40:47.079 switching all around the world towards 00:40:46.039 --> 00:40:48.759 your goods so you're going to end up 00:40:47.079 --> 00:40:52.318 producing 00:40:48.760 --> 00:40:54.640 more okay and so suppose that you didn't 00:40:52.318 --> 00:40:56.838 want that extra production you just 00:40:54.639 --> 00:40:58.920 wanted to fix your trade balance then 00:40:56.838 --> 00:41:01.639 you have to said that and that's what 00:40:58.920 --> 00:41:03.318 I've done here typ that's very typical 00:41:01.639 --> 00:41:05.400 is supposed you're a situation where you 00:41:03.318 --> 00:41:06.960 have very large trade deficit but you 00:41:05.400 --> 00:41:09.160 are okay with the equilibrium level of 00:41:06.960 --> 00:41:11.000 output you have and a typical package is 00:41:09.159 --> 00:41:13.519 you depreciate your currency but you 00:41:11.000 --> 00:41:15.838 also reduce govern expenditure okay 00:41:13.519 --> 00:41:18.199 because depreciation of the currency is 00:41:15.838 --> 00:41:19.279 expansionary it's expansionary improves 00:41:18.199 --> 00:41:20.838 the trade deficit but it's also 00:41:19.280 --> 00:41:23.119 expansionary because you relocate 00:41:20.838 --> 00:41:24.679 expenditure both of residents and 00:41:23.119 --> 00:41:26.640 foreigners towards your good that 00:41:24.679 --> 00:41:27.759 increases demand for your good increases 00:41:26.639 --> 00:41:31.838 out 00:41:27.760 --> 00:41:31.839 but um 00:41:32.199 --> 00:41:37.879 um I mean if I don't like that I have 00:41:35.079 --> 00:41:40.680 many ways of of setting that one of them 00:41:37.880 --> 00:41:43.880 is by reducing government expenditure 00:41:40.679 --> 00:41:43.879 okay so that's what I've done 00:41:44.920 --> 00:41:50.440 here again this is a great package you 00:41:47.719 --> 00:41:52.000 see this is doing remember I told you 00:41:50.440 --> 00:41:55.559 here 00:41:52.000 --> 00:41:58.559 that people tend to prefer remember I 00:41:55.559 --> 00:42:00.078 said you know this is this is one way of 00:41:58.559 --> 00:42:04.358 of increasing output if you want to 00:42:00.079 --> 00:42:08.200 increase output H um another 00:42:04.358 --> 00:42:10.440 way is is to do it by exports 00:42:08.199 --> 00:42:11.919 Rising if I don't want to increase out 00:42:10.440 --> 00:42:15.440 but this is better because this 00:42:11.920 --> 00:42:18.599 increases the trade balance well suppose 00:42:15.440 --> 00:42:20.679 I do I which is where index is I do the 00:42:18.599 --> 00:42:24.960 converse suppose I don't want to change 00:42:20.679 --> 00:42:26.639 output I want to increase the net export 00:42:24.960 --> 00:42:28.720 well these two charts this and the 00:42:26.639 --> 00:42:31.199 previous one tell me exactly how to do 00:42:28.719 --> 00:42:33.399 it I use this for the expansion of 00:42:31.199 --> 00:42:35.639 output and to improve the net 00:42:33.400 --> 00:42:37.039 exports and I use the other one to 00:42:35.639 --> 00:42:40.118 offset the effect on 00:42:37.039 --> 00:42:44.318 output but with the opposite 00:42:40.119 --> 00:42:47.920 sign so I use this but with a decline in 00:42:44.318 --> 00:42:50.519 G that's exactly what I did here so 00:42:47.920 --> 00:42:53.240 that's very tempting for a country to 00:42:50.519 --> 00:42:56.440 okay to depreciate the currency and at 00:42:53.239 --> 00:42:57.959 the same time H if you think that you 00:42:56.440 --> 00:43:00.039 need to pull off the economy then you 00:42:57.960 --> 00:43:03.559 can use some other instrument domestic 00:43:00.039 --> 00:43:06.239 instrument to to do that for a long time 00:43:03.559 --> 00:43:08.720 China was accused of doing just this it 00:43:06.239 --> 00:43:12.318 was called the mercantilist policies of 00:43:08.719 --> 00:43:15.480 China and and especially sort of in late 00:43:12.318 --> 00:43:18.838 90s and 2000s and so on China had 00:43:15.480 --> 00:43:23.639 massive amount of exports and and the US 00:43:18.838 --> 00:43:25.838 had huge trade deficit was called was 00:43:23.639 --> 00:43:29.519 called the the the time of the global 00:43:25.838 --> 00:43:35.519 imbalances big deficit in the US big 00:43:29.519 --> 00:43:37.119 Surplus in in in in the in China and and 00:43:35.519 --> 00:43:40.318 the rest of the world kept accusing 00:43:37.119 --> 00:43:44.760 China of really M maintaining their 00:43:40.318 --> 00:43:47.480 currency at artificially low levels okay 00:43:44.760 --> 00:43:51.599 with the purpose of doing 00:43:47.480 --> 00:43:55.280 that uh anyways I'm not going to take 00:43:51.599 --> 00:43:55.280 sight on that I think that 00:43:55.358 --> 00:44:00.719 that that the reason why the currency 00:43:57.920 --> 00:44:02.159 was the Chinese REM was so depreciated 00:44:00.719 --> 00:44:03.558 was different from that but that's a 00:44:02.159 --> 00:44:06.639 different 00:44:03.559 --> 00:44:09.960 story but the result was this it was 00:44:06.639 --> 00:44:13.558 that they had very large trade 00:44:09.960 --> 00:44:15.639 surpluses and uh the result was this 00:44:13.559 --> 00:44:17.839 they had very large trade surpluses and 00:44:15.639 --> 00:44:21.440 they grew a lot 00:44:17.838 --> 00:44:23.119 so because they had this but it was very 00:44:21.440 --> 00:44:25.720 export driven it was the rest of the 00:44:23.119 --> 00:44:27.559 world pulling in fact the domestic 00:44:25.719 --> 00:44:29.879 economy in China they were saying a lot 00:44:27.559 --> 00:44:31.920 so domestic consumption was very low but 00:44:29.880 --> 00:44:35.680 they had massive amount of exports and 00:44:31.920 --> 00:44:39.559 that's what was P pulling their output 00:44:35.679 --> 00:44:41.679 up so open economy you get new 00:44:39.559 --> 00:44:44.960 tools okay so that's all that I want to 00:44:41.679 --> 00:44:48.159 say for today um so 00:44:44.960 --> 00:44:50.000 summary uh very important demand for 00:44:48.159 --> 00:44:53.078 domestic Goods is no longer equal to 00:44:50.000 --> 00:44:55.480 domestic uh demand for 00:44:53.079 --> 00:44:57.800 goods because part of the latter will go 00:44:55.480 --> 00:45:01.480 to a for foreign 00:44:57.800 --> 00:45:03.839 goods and and also part of the former 00:45:01.480 --> 00:45:06.400 will come from foreign demand okay so 00:45:03.838 --> 00:45:08.880 that's that's a the that's what is new 00:45:06.400 --> 00:45:10.440 of this part you have an extra component 00:45:08.880 --> 00:45:12.119 and then the other thing that is new of 00:45:10.440 --> 00:45:13.760 this part of the course is that well 00:45:12.119 --> 00:45:15.440 these extra components the exports and 00:45:13.760 --> 00:45:18.640 the Imports are functions of things that 00:45:15.440 --> 00:45:21.358 w we didn't have before for an output 00:45:18.639 --> 00:45:23.000 the exchange rate in particular 00:45:21.358 --> 00:45:26.960 okay 00:45:23.000 --> 00:45:31.239 um so equilibrium output again is the 00:45:26.960 --> 00:45:32.639 determined by a output domestic output 00:45:31.239 --> 00:45:36.118 equal to 00:45:32.639 --> 00:45:36.118 that not to 00:45:36.159 --> 00:45:40.279 that the difference between the two is 00:45:38.519 --> 00:45:42.960 reflecting the trade 00:45:40.280 --> 00:45:44.599 balance ER so the trade another way of 00:45:42.960 --> 00:45:47.159 thinking about the trade balance is 00:45:44.599 --> 00:45:51.119 simply the difference between the demand 00:45:47.159 --> 00:45:53.318 for a um domestic goods and the domestic 00:45:51.119 --> 00:45:55.680 demand for goods so the trade balance is 00:45:53.318 --> 00:45:59.719 nothing else than that DD curve minus 00:45:55.679 --> 00:46:04.159 the ZZ curve that's a trade balance okay 00:45:59.719 --> 00:46:05.519 sorry the zzer minus the the deer that's 00:46:04.159 --> 00:46:10.199 that's net 00:46:05.519 --> 00:46:14.800 export okay sorry let me write that down 00:46:10.199 --> 00:46:21.239 because so remember that we started from 00:46:14.800 --> 00:46:23.800 the demand which was C + I + G that's 00:46:21.239 --> 00:46:30.118 the domestic demand for 00:46:23.800 --> 00:46:32.240 goods we went to Z e is equal to 00:46:30.119 --> 00:46:34.079 demand 00:46:32.239 --> 00:46:38.399 plus net 00:46:34.079 --> 00:46:42.200 export okay so what I'm saying 00:46:38.400 --> 00:46:42.200 is that net 00:46:42.639 --> 00:46:51.400 export is just equal to Z minus D okay 00:46:48.639 --> 00:46:53.118 so that's the reason you can very early 00:46:51.400 --> 00:46:56.960 on 00:46:53.119 --> 00:47:02.200 when I show you this thing here the if 00:46:56.960 --> 00:47:05.000 distance between ZZ and d d is this n 00:47:02.199 --> 00:47:06.759 export here okay that's a reason when 00:47:05.000 --> 00:47:10.480 the two of them are the same that also 00:47:06.760 --> 00:47:12.680 means that n export is equal to zero 00:47:10.480 --> 00:47:14.679 very important also message from this 00:47:12.679 --> 00:47:17.239 part of of of the course is that a 00:47:14.679 --> 00:47:18.919 depreciation improves the trade balance 00:47:17.239 --> 00:47:20.318 and increases the amount for domestic 00:47:18.920 --> 00:47:22.880 Goods again that's what it's called 00:47:20.318 --> 00:47:26.000 expenditure switching mechanism the 00:47:22.880 --> 00:47:28.119 expenditures both of domestic of 00:47:26.000 --> 00:47:29.440 residents and foreign switches towards 00:47:28.119 --> 00:47:32.160 domestic 00:47:29.440 --> 00:47:35.440 good 00:47:32.159 --> 00:47:37.358 ER and that's also very important for a 00:47:35.440 --> 00:47:40.720 given exchange rate changes in aggregate 00:47:37.358 --> 00:47:42.400 demand in one large country H induced by 00:47:40.719 --> 00:47:43.598 policy or the private sector in this 00:47:42.400 --> 00:47:46.559 case China 00:47:43.599 --> 00:47:49.800 reopening ER affects other countries 00:47:46.559 --> 00:47:53.200 through why star through 00:47:49.800 --> 00:47:54.800 exports okay so I'm going to stop here 00:47:53.199 --> 00:47:58.000 and in the next lecture what we'll do is 00:47:54.800 --> 00:48:00.039 we'll integrate this with the H 00:47:58.000 --> 00:48:01.719 Financial opening and and that will get 00:48:00.039 --> 00:48:03.279 us to what I think is one of the most 00:48:01.719 --> 00:48:07.279 important malls in this course which is 00:48:03.280 --> 00:48:07.280 called the Mandel flaming Mall