Intermediate
Macroeconomics
Lecture 14
2
Effects of Policies on Real Ex-rate
1,Home fiscal policy (expansionary)
? S ↓? (S – I) ↓
? Domestic currency invested abroad ↓
? Domestic currency appreciates
? Nominal ex-rate ↑
? Real ex-rate ↑(if prices do not change)
? Domestic goods become more expensive
? Exports ↓ & imports ↑
? NX ↓
3
Effects of Policies on Real Ex-rate
NX
ε
S-I
NX(ε)
4
Effects of Policies on Real Ex-rate
2,Fiscal policy abroad (expansionary)
Foreign S ↓
? foreign (S-I) ↓
? r*↑? I ↓? (S-I) ↑
? Supply of domestic currency ↑
? Nominal ex-rate ↓
? Real ex-rate ↓(if prices keep the same)
? Domestic goods become cheaper
? Exports ↑ & imports ↓
? NX↑
5
Effects of Policies on Real Ex-rate
NX
ε
S-I
NX(ε)
6
Effects of Policies on Real Ex-rate
3,Change in investment demand
I,S
I ( r*)
S r
r*
S I I’ NX
?
NX( ) ?
S-I
7
Effects of Policies on Real Ex-rate
? I↓
? (S-I) ↑
? supply of domestic currency ↑
? domestic currency depreciates
? nominal ex-rate ↓
? real ex-rate ↓
? domestic goods cheaper
? EX ↑ & IM ↓
? NX ↑
8
Effects of Trade Policies
? Trade policies
1,Tariff,placing a tax on foreign
imports
2,Quota,restricting the amount of
imports
9
Effects of Trade Policies
? Consider an extreme case,prohibit
imports
? Imports ↓& NX ↑(at the original ex-
rate)
? supply for domestic currency ↓
? domestic currency appreciates
? ex-rates ↑
10
Effects of Trade Policies
? Prohibited trade policy
NX
?
NX( ) ?
S-I
NX1=NX2
11
Determinants of Nominal Ex-
rate
*
Pe
P? ??
*Pe
P???
? From real ex-rate
?Nominal ex-rate depends on the real
ex-rate and the p levels in the 2 countries
12
Determinants of Nominal Ex-
rate
? We cannot see real ex-rate
? The law of one price
? Purchasing-power parity (w/ arbitrage)
13
Determinants of Nominal Ex-
rate
e.g,
The Beatle is $20,000 in the U.S,and
RMB ￥ 470,000 in China,What is the
nominal ex-rate? How would
arbitrageurs act?
14
Determinants of Nominal Ex-
rate
? PPP ? real ex-rate = 1
NX
S-I
NX
?
1
15
Determinants of Nominal Ex-
rate
? Real ex-rate = 1
? Change in S-I only affects NX and
nominal ex-rate,not real ex-rate
? Any change in the relative price levels
of the 2 countries will change nominal
ex-rate
16
The Big Mac Index (1997)
ex-rates (per U.S.$)
currency predicted actual (under-/over+)%
Argentina Peso 1.03 1 3
Australia Dollar 1.03 1.29 -20.155
Canada Dollar 1.19 1.39 -14.3885
China RMB 4.01 8.33 -51.8607
France Franc 7.23 5.76 25.52083
Germany Mark 2.02 1.71 18.12865
Japan Yen 121 126 -3.96825
Korea,Rep,Won 950 894 6.263982
Mexico Peso 6.16 7.9 -22.0253
Russia Ruble 4545 5739 -20.805
Singapore Dollar 1.24 1.44 -13.8889
Thailand Baht 19.3 26.1 -26.0536
U.K,Pound 0.75 0.61 22.95082
17
18
Large Open Economy
? Large economy affects world i-rate
? Capital is not perfectly mobile
? NFI is negatively correlated with r
r
NFI 0 Net borrower
(NFI<0) Net lender (NFI>0)
19
Large Open Economy
? Comparison of NFI
r
NFI
r
NFI
Closed economy SOE w/ perfectly mobile K
20
Large Open Economy
? Model
1,Loanable funds market
(S = I+NFI)
(investment & savings ? r)
2,NFI & r
(r ? NFI)
3,Exchange market
(NFI = NX ?real ex-rate)
21
Large Open Economy
S,I+NFI
S r
NFI
r
I+NFI NFI( r )
NX
NFI ?
NX( ) ?
22
Large Open Economy
? Domestic fiscal policies (expansionary)
NFI( r )
NX
NFI ?
NX( ) ?
r
S,I+NFI
S
I+NFI
r
NFI
23
Large Open Economy
? Expansionary fiscal policies at home
_______ the national savings
_______ the real interest rate
_______ the NFI
_______ the NX
_______ the real ex-rate
24
Large Open Economy
? Demand for investment
NFI( r )
NFI ?
NX( )
r
S,I+NFI
r
NFI
S
?
I+NFI
25
Large Open Economy
? Increasing D for investment at home
_______ the national savings
_______ the real interest rate
_______ the NFI
_______ the NX
_______ the real ex-rate
26
Large Open Economy
? Domestic trade policy
NFI( r )
NFI ?
NX( )
r
NFI
S
?
r
S,I+NFI
I+NFI
27
Large Open Economy
? Protective trade policy at home
_______ the national savings
_______ the real interest rate
_______ the NFI
_______ the NX
_______ the real ex-rate
28
Large Open Economy
? Shifts in NFI
1,Fiscal policy policies abroad
2,Unstable political environment
29
Large Open Economy
? Expansionary fiscal policies abroad
NFI( r )
NFI ?
NX( )
r
NFI
S
?
r
S,I+NFI
I+NFI
Macroeconomics
Lecture 14
2
Effects of Policies on Real Ex-rate
1,Home fiscal policy (expansionary)
? S ↓? (S – I) ↓
? Domestic currency invested abroad ↓
? Domestic currency appreciates
? Nominal ex-rate ↑
? Real ex-rate ↑(if prices do not change)
? Domestic goods become more expensive
? Exports ↓ & imports ↑
? NX ↓
3
Effects of Policies on Real Ex-rate
NX
ε
S-I
NX(ε)
4
Effects of Policies on Real Ex-rate
2,Fiscal policy abroad (expansionary)
Foreign S ↓
? foreign (S-I) ↓
? r*↑? I ↓? (S-I) ↑
? Supply of domestic currency ↑
? Nominal ex-rate ↓
? Real ex-rate ↓(if prices keep the same)
? Domestic goods become cheaper
? Exports ↑ & imports ↓
? NX↑
5
Effects of Policies on Real Ex-rate
NX
ε
S-I
NX(ε)
6
Effects of Policies on Real Ex-rate
3,Change in investment demand
I,S
I ( r*)
S r
r*
S I I’ NX
?
NX( ) ?
S-I
7
Effects of Policies on Real Ex-rate
? I↓
? (S-I) ↑
? supply of domestic currency ↑
? domestic currency depreciates
? nominal ex-rate ↓
? real ex-rate ↓
? domestic goods cheaper
? EX ↑ & IM ↓
? NX ↑
8
Effects of Trade Policies
? Trade policies
1,Tariff,placing a tax on foreign
imports
2,Quota,restricting the amount of
imports
9
Effects of Trade Policies
? Consider an extreme case,prohibit
imports
? Imports ↓& NX ↑(at the original ex-
rate)
? supply for domestic currency ↓
? domestic currency appreciates
? ex-rates ↑
10
Effects of Trade Policies
? Prohibited trade policy
NX
?
NX( ) ?
S-I
NX1=NX2
11
Determinants of Nominal Ex-
rate
*
Pe
P? ??
*Pe
P???
? From real ex-rate
?Nominal ex-rate depends on the real
ex-rate and the p levels in the 2 countries
12
Determinants of Nominal Ex-
rate
? We cannot see real ex-rate
? The law of one price
? Purchasing-power parity (w/ arbitrage)
13
Determinants of Nominal Ex-
rate
e.g,
The Beatle is $20,000 in the U.S,and
RMB ￥ 470,000 in China,What is the
nominal ex-rate? How would
arbitrageurs act?
14
Determinants of Nominal Ex-
rate
? PPP ? real ex-rate = 1
NX
S-I
NX
?
1
15
Determinants of Nominal Ex-
rate
? Real ex-rate = 1
? Change in S-I only affects NX and
nominal ex-rate,not real ex-rate
? Any change in the relative price levels
of the 2 countries will change nominal
ex-rate
16
The Big Mac Index (1997)
ex-rates (per U.S.$)
currency predicted actual (under-/over+)%
Argentina Peso 1.03 1 3
Australia Dollar 1.03 1.29 -20.155
Canada Dollar 1.19 1.39 -14.3885
China RMB 4.01 8.33 -51.8607
France Franc 7.23 5.76 25.52083
Germany Mark 2.02 1.71 18.12865
Japan Yen 121 126 -3.96825
Korea,Rep,Won 950 894 6.263982
Mexico Peso 6.16 7.9 -22.0253
Russia Ruble 4545 5739 -20.805
Singapore Dollar 1.24 1.44 -13.8889
Thailand Baht 19.3 26.1 -26.0536
U.K,Pound 0.75 0.61 22.95082
17
18
Large Open Economy
? Large economy affects world i-rate
? Capital is not perfectly mobile
? NFI is negatively correlated with r
r
NFI 0 Net borrower
(NFI<0) Net lender (NFI>0)
19
Large Open Economy
? Comparison of NFI
r
NFI
r
NFI
Closed economy SOE w/ perfectly mobile K
20
Large Open Economy
? Model
1,Loanable funds market
(S = I+NFI)
(investment & savings ? r)
2,NFI & r
(r ? NFI)
3,Exchange market
(NFI = NX ?real ex-rate)
21
Large Open Economy
S,I+NFI
S r
NFI
r
I+NFI NFI( r )
NX
NFI ?
NX( ) ?
22
Large Open Economy
? Domestic fiscal policies (expansionary)
NFI( r )
NX
NFI ?
NX( ) ?
r
S,I+NFI
S
I+NFI
r
NFI
23
Large Open Economy
? Expansionary fiscal policies at home
_______ the national savings
_______ the real interest rate
_______ the NFI
_______ the NX
_______ the real ex-rate
24
Large Open Economy
? Demand for investment
NFI( r )
NFI ?
NX( )
r
S,I+NFI
r
NFI
S
?
I+NFI
25
Large Open Economy
? Increasing D for investment at home
_______ the national savings
_______ the real interest rate
_______ the NFI
_______ the NX
_______ the real ex-rate
26
Large Open Economy
? Domestic trade policy
NFI( r )
NFI ?
NX( )
r
NFI
S
?
r
S,I+NFI
I+NFI
27
Large Open Economy
? Protective trade policy at home
_______ the national savings
_______ the real interest rate
_______ the NFI
_______ the NX
_______ the real ex-rate
28
Large Open Economy
? Shifts in NFI
1,Fiscal policy policies abroad
2,Unstable political environment
29
Large Open Economy
? Expansionary fiscal policies abroad
NFI( r )
NFI ?
NX( )
r
NFI
S
?
r
S,I+NFI
I+NFI
