intermediate macroeconomics/menu/... · 2015-01-23 · intermediate macroeconomics l1: national...
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![Page 1: Intermediate Macroeconomics/menu/... · 2015-01-23 · Intermediate Macroeconomics L1: National Income in Closed and Open Economies Anna Seim Department of Economics, Stockholm University](https://reader030.vdocuments.site/reader030/viewer/2022040614/5f0959627e708231d426690e/html5/thumbnails/1.jpg)
Intermediate MacroeconomicsL1: National Income in Closed and Open Economies
Anna Seim
Department of Economics, Stockholm University
Spring 2015
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Topics
• The relationship between• Saving and investment in a closed economy• Saving, investment and the current account in an openeconomy
• Fiscal deficits and the real interest rate• Fiscal deficits and the current account• The real exchange rate and the current account
• Contemporary trade imbalances
Literature: Mankiw, Chapters 3 and 6, EEAG (2014), Ch. 1.
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The closed economy
Y = F (K , L) Production functionK = K Given capital stockL = L Given labour forceY = C + I + G Goods market equilibriumC = C (Y − T ) Consumption functionI = I (r) Investment functionG = G Given government expenditureT = T Given lump sum tax
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EquilibriumGoods market:
Y = C(Y − T
)+ I (r) + G
G ↑=⇒ r ↑=⇒ I ↓Credit market (market for "loanable funds"):
S = Y − C(Y − T
)− G = I (r)
Saving = Investment
S =[Y − T − C
(Y − T
)]+[T − G
]= I (r)
Private saving + Government saving = Investment
G ↑=⇒ r ↑=⇒ I ↓Analysis of tax cuts: similar
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Fig 3-6: The consumption function
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Fig 3-7: The investment function
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Fig 3-8: Saving, investment and the interest rate
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Fig 3-9: A reduction in saving
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Fig 3-10: Military spending and the interest rate in theUnited Kingdom
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The current situation
• Fiscal deficits in many countries• Insuffi cient fiscal restraint in good times• Fall in tax revenue during the crisis• Support to financial sector• Fiscal stimulus programmes
• High interest rates in countries with solvency problems• So far low interest rates in countries that do not suffer fromcredibility problems
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Table 1.2, EEAG Report 2014
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Fig 1.21, EEAG Report 2014
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Fig 3-11: An increase in the demand for investment
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Fig 3-12: An Increase in investment demand when savingdepends on the interest rate
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Equilibrium in the open economy
Y = C d + I d + G d + EX
C = C d + C f ⇒ C d = C − C f
I = I d + I f ⇒ I d = I − I f
G = G d + G f ⇒ G d = G − G f
Y =(C − C f
)+(I − I f
)+(G − G f
)+ EX
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Equilibrium in the open economy cont’d.
Y = C + I + G + EX −(C f + I f + G f
)︸ ︷︷ ︸
IM
Y = C + I + G + EX − IM︸ ︷︷ ︸NX
Y = C + I + G +NX ⇐⇒NX = Y − (C + I + G )︸ ︷︷ ︸
A
where A = absorption (domestic spending).
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Saving-investment balance in an open economy
S = Y − C − G = I +NXTwo types of saving: accumulation of real capital (I ) oraccumulation of financial claims on the rest of the world resultingfrom net exports (NX )
S − I = NX
• Net exports are the difference between saving and investment• Net exports = trade balance• Saving minus investment = net capital outflow (net foreigninvestment)
• Net capital outflow• Lending to foreign banks• Purchases of foreign assets (bonds, equity, real estate)
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Saving-investment balance in an open economy cont’d.
Y = C + I + G +NX
GDP = C + I + G +NX
GNP = GDP +NFIA
• NFIA = Net Factor Income from Abroad = Factor paymentsfrom abroad - Factor payments to abroad
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A model of a small open economy
r = r ∗
Y = Y = F (K , L)
C = C (Y − T )I = I (r)
NX =(Y − C − G
)− I = S − I
Reduced form:
NX =[Y − C
(Y − T
)− G
]− I (r ∗)
NX = S − I (r ∗)
Net exports are given by the difference between saving andinvestment at the world market real interest rate
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Fig 6-2: Saving and investment in a small open economy
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Fig 6-3: A fiscal expansion at home in a small openeconomy
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Fig 6-4: A fiscal expansion abroad in a small open economy
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Fig 6-5: A shift in the investment schedule in a small openeconomy
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Fig 6-6: The trade balance, saving, and investment: theUS experience
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The Current Account
The current account balance = Net exports + Net return onforeign assets:
CA = NX + rNFA
CA = current accountNX = net exportsr = interest rateNFA = net foreign assets = foreign assets - foreign debt
Mankiw simplifies the analysis by neglecting the return on foreignassets
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The real exchange rate
The relative price between domestic and foreign goodsp = Swedish product price in SEKp∗ = foreign product price in $e = nominal exchange rate (units of $ per SEK )ε = real exchange rate
ε =epp∗
∆ε
ε≈ ∆e
e+
∆pp− ∆p∗
p∗
Percentage change in the real exchange rate ≈ percentage changein nominal exchange rate + percentage change in Swedish productprice - percentage change in foreign product price
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The real exchange rate cont’d.
ε ↓: real depreciation (relative price of domestic goods decreases)ε ↑: real appreciation (relative price of domestic goods increases)
NX = NX (ε)
Net exports are negatively related to the real exchange rate
ε ↑=⇒ NX ↓
A real depreciation causes an improvement of the trade balance:
ε ↓=⇒ NX ↑
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Fig 6-7: Net exports and the real exchange rate
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Fig 6-8: How the real exchange rate is determined
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Fig 6-9: The impact of expansionary fiscal policy at homeon the real exchange rate
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Fig 6-10: The impact of expansionary fiscal policy abroadon the real exchange rate
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Fig 6-11: The impact of an increase in investment demandon the real exchange rate
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Causes for global imbalances
• Global imbalances in recent years: large US current accountdeficit and Chinese current account surplus
• Low US savings (both governments and households)• "Saving glut" in ROW (China and other Asian countries)
• "Export-led growth" in China and other Asian countries• Elimination of the US current account deficit requires largeUS real exchange rate depreciation
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Global current account balances 2001-2010
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Current account balances 2005-2010
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Current account balances 1995-2011
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Elimination of current account deficits
• Requires real exchange rate depreciations• Sweden ran large current account deficits prior to the crisis inthe 1990s
• Eliminated by large nominal (and real) depreciation when thefixed exchange rate was abandoned 1992
• Large current account surpluses in Sweden from the mid 90sonwards
• Largely due to fiscal consolidation
• Greece, Portugal, Ireland, Spain and Italy have had currentaccount deficits after large real exchange rate appreciations
• Real depreciations diffi cult to achieve when the exchange rateis fixed as within the EMU
• Lower inflation (wage and price cuts) needed to achieve realdepreciation
• Lower inflation in crisis countries, and higher inflation inGermany and other surplus countries, desirable
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Unit labour cost and the real exchange rate
• Define unit labour cost (ULC), the labour cost of producingone unit of output:
ULC =WLY
where W is the wage, L, employment and Y is output.
• Instead of ε = epp∗ , one often uses relative unit labour costs
(RULC) as a measure of the real exchange rate:
RULC = eULCULC ∗
where ULC ∗ is foreign unit labour cost.
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Topics
• The relationship between• Saving and investment in a closed economy• Saving, investment and the current account in an openeconomy
• Fiscal deficits and the real interest rate• Fiscal deficits and the current account• The real exchange rate and the current account
• Contemporary trade imbalances
Literature: Mankiw, Chapters 3 and 6, EEAG (2014), Ch. 1.