Professional Documents
Culture Documents
The Open Economy: Acroeconomics
The Open Economy: Acroeconomics
CHAPTER
N. GREGORY MANKIW
PowerPoint® Slides by Ron Cronovich
© 2007 Worth Publishers, all rights reserved
In this chapter, you will learn…
EX = exports =
foreign spending on domestic goods
IM = imports = C f + I f + G f
= spending on foreign goods
NX = net exports (a.k.a. the “trade balance”)
= EX – IM
CHAPTER 5 The Open Economy slide 4
GDP = expenditure on
domestically produced g & s
Y C d I d G d EX
f f f
(C C ) (I I ) (G G ) EX
C I G EX (C f I f G f )
C I G EX IM
C I G NX
Y = C + I + G + NX
or, NX = Y – (C + I + G )
domestic
spending
net exports
output
NX = EX – IM = Y – (C + I + G )
trade surplus:
output > spending and exports > imports
Size of the trade surplus = NX
trade deficit:
spending > output and imports > exports
Size of the trade deficit = –NX
0 0%
billions of dollars
percent of GDP
-200 -2%
-400 -4%
-600 -6%
-800 -8%
1950 1960 1970 1980 1990 2000
NX ($ billions) NX (% of GDP)
International capital flows
NX = Y – (C + I + G )
implies
NX = (Y – C – G ) – I
= S – I
trade balance = net capital outflow
Thus,
a country with a trade deficit (NX < 0)
is a net borrower (S < I ).
r S Y C (Y T ) G
As in Chapter 3,
national saving does
not depend on the
interest rate
S S, I
CHAPTER 5 The Open Economy slide 13
Assumptions re: Capital flows
a & b imply r = r*
c implies r* is exogenous
CHAPTER 5 The Open Economy slide 14
Investment:
The demand for loanable funds
Investment is still a
r
downward-sloping function
of the interest rate,
but the exogenous
world interest rate…
r* …determines the
country’s level of
investment.
I (r )
I (r* ) S, I
CHAPTER 5 The Open Economy slide 15
If the economy were closed…
r S
…the interest
rate would
adjust to
equate
investment
and saving: rc
I (r )
I (rc ) S, I
S
CHAPTER 5 The Open Economy slide 16
But in a small open economy…
r
the exogenous S
world interest
rate determines
investment… NX
r*
…and the
difference rc
between saving
and investment I (r )
determines net
capital outflow I1 S, I
and net exports
CHAPTER 5 The Open Economy slide 17
Next, three experiments:
NX1
Results:
I 0
NX S 0 I (r )
I1 S, I
4%
0%
2%
-2%
0%
Results:
I 0 I (r )
NX I 0
S, I
I (r )
2
*
I (r1* )
r*
EXERCISE:
Use the model to NX1
determine the impact
of an increase in
investment demand I (r )1
on NX, S, I, and
net capital outflow. I1 S, I
I1 I2 S, I
-1%
80
-2%
60
-3%
-4% 40
Net exports
-5% (left scale)
20
-6%
-7% 0
1973 1977 1981 1985 1989 1993 1997 2001 2005
CHAPTER 5 The Open Economy slide 31
The net exports function
NX = NX(ε )
so U.S. net
When ε is exports will
relatively low, be high
U.S. goods are
relatively ε1
inexpensive
NX (ε)
0
NX(ε1) NX
CHAPTER 5 The Open Economy slide 33
The NX curve for the U.S.
ε At high enough
values of ε,
ε2 U.S. goods become
so expensive that
we export
less than
we import
NX (ε)
NX(ε2) 0 NX
CHAPTER 5 The Open Economy slide 34
How ε is determined
ε1
ε adjusts to
equate NX NX(ε )
with net capital
outflow, S I. NX
NX 1
supply: ε1
Net capital
outflow (S I ) NX(ε )
is the supply of
NX
dollars to be NX 1
invested abroad.
CHAPTER 5 The Open Economy slide 37
Next, four experiments:
A fiscal expansion S 2 I (r *)
reduces national ε S 1 I (r *)
saving, net capital
outflow, and the ε2
supply of dollars
in the foreign
exchange ε1
market…
NX(ε )
…causing the real
NX
exchange rate to NX 2 NX 1
rise and NX to fall.
CHAPTER 5 The Open Economy slide 39
2. Fiscal policy abroad
An increase in r* S 1 I (r1 *)
reduces
ε S 1 I (r2 *)
investment,
increasing net
capital outflow ε1
and the supply of
dollars in the ε2
foreign exchange
market… NX(ε )
Results:
ε S I
ε > 0
(demand
increase) ε2
NX = 0
(supply fixed) ε1
IM < 0 NX (ε )2
(policy)
NX (ε )1
EX < 0
(rise in ε ) NX
NX1
P*
e ε
P
M
L (r * , Y )
NX (ε ) S I (r *) P
e ε P * P ε
*
e ε P* P ε
For a given value of ε,
the growth rate of e equals the difference
between foreign and domestic inflation rates.
CHAPTER 5 The Open Economy slide 46
Inflation differentials and nominal
exchange rates
35
Percentage Mexico
30
change in
nominal 25
exchange
20 Iceland
rate
15
10 Singapore
South Africa
Canada
5 South Korea
_
0 U.K.
Japan
-5
-5 0 5 10 15 20 25 30
Inflation differential
CHAPTER 5 The Open Economy slide 47
Purchasing Power Parity (PPP)
Two definitions:
A doctrine that states that goods must sell at the
same (currency-adjusted) price in all countries.
The nominal exchange rate adjusts to equalize
the cost of a basket of goods across countries.
Reasoning:
arbitrage, the law of one price
NX
CHAPTER 5 The Open Economy slide 50
Does PPP hold in the real world?
Impact of policies on NX :
NX increases if policy causes S to rise
or I to fall
NX does not change if policy affects
neither S nor I. Example: trade policy
Exchange rates
nominal: the price of a country’s currency in
terms of another country’s currency
real: the price of a country’s goods in terms of
another country’s goods
The real exchange rate equals the nominal rate
times the ratio of prices of the two countries.