Chapter 10
Open Economy
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
Topics to be Discussed
? National Income Accounting and the
Balance of Payments & other concepts
? The determination of exchange rate
? floating exchange rate system
? Fixed exchange rate system
? Trade environment and policy
? Summary of the open economy
10.1 National Income Accounting and
the Balance of Payments & Other
Concepts
? Balance of Payment, recording the financial
capital debit and credit,purchases or sales of
investment assets, exports or imports of goods
or services,etc,Balance of payments include
capital account,current account and balance
account,
? The Balance of Payments Accounts, a
systematical report forms of all economic
transactions in a period,including current item、
capital item and balance item,
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
? Current item,or goods and labor services item,including,goods
(imports and exports); labor services,such as,transportation、
insurance, traveling, investment labor services (interest,
dividend, profit) and other labor ； international unilateral
transfer,such as religion,charity,donation to the education、
non-war reparations,etc,
? Capital item,all of the exchange activities facing exterior capital
and debts,such as investment, stocks and bond trading,etc,
? Official repertory item, the exterior net trading of national
currency department,including gold, foreign exchange
repertory,etc,If the credit is larger than the debit,then the item
will increase; otherwise,if the debit is larger than the credit,then
the item will decrease,
? Error item,balance through this item if the credit does equal to
the debit,
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
)( *RRaCF ??
?Capital account,recording international investment and debit and
credit,International investment includes the foreign real estate, foreign
corporations’ stocks, foreign governments’ bonds of individual、
corporation and government,and the domestic real estate,stocks and
government bonds purchased by the foreign individual,corporations
and governments,International debit and credit includes the domestic
corporation and government’ loan get from foreign bank,fund and
governments,and the funds lent by the foreign corporations and
governments,Capital mobility is defined CF,R is domestic interest,R* is
the foreign interest,a is the coefficient,then,
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
?Current account,mainly be used to record the total
amount of imports and exports in goods and services,
Including Net Export,Investment Income,Transfer
Payment,Defining that the NX is the net export,Y is
the national income,E is the nominal exchange rate,
P is the domestic price,P*is the foreign price,then,
*P
PEmnYgNX ????
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
?Because the Balance of Payments (BP） can be abbreviated to
capital mobility and net export,then,
*
* )(
P
P
EmnYgRRa
NXCFBP
??????
??
10.2 The Determination of The
Exchange Rate
? Exchange rate is the relative price of the
domestic currency and the foreign currency,
and plays an important role in the international
economic activities,
? The change of the exchange rate can directly
affect the net export,
? The exchange rate can affect the domestic
gross demand through the net export,
10.2 The Determination of The
Exchange Rate
?A highly-abbreviated model
?There are only two countries in the world,one is China,
the other is Canada; They only produce one product,
corn,people consume corn,and use it to invest（
seeds),government uses corn to pay,If the price of corn
is 1yuan per kilogram in China,1 Canadian dollar per
kilogram in Canada。 Then the rate of exchange of RMB
to Canadian dollar should be？
1,1 namely1RMB exchange
1Canadian dollar
10.2 The Determination of The
Exchange Rate
?Suppose that if the price of corn in China is 2yuan per
kilogram,and 1Canadian dollar per kilogram in Canada,Then
what should the rate of exchange from RMB to Canadian dollar
be？ 2:1 namely 2yuan RMB
exchanges1Canadian dollars
?Otherwise,if the price of corn in Canada rise to 2yuanRMB
per kilogram,and 1Canadian dollar per kilogram in China,
Then what should the rate of exchange from RMB to Canadian
dollar be？
1:2namely 1yuan RMB exchange 2
Canadian dollars
10.2 The Determination of The
Exchange Rate
?conclusion,exchange rate is determined by the
price of the two countries,The price of one country
rise,its currency will be depreciated; vice versa,
10.2 The Determination of The
Exchange Rate
? Quotations and the method of quoting price of
exchange rate
? quotations,
?Use some currency as the standards of
other currencies when weighing the price,
?Because the market of exchange rate can
be divided into wholesale market between
the international banks and the retail
market between bank and customers I,
then the method of quotation is different,
10.2 The Determination of The
Exchange Rate
? Quotations and the method of quoting price of
exchange rate
?Two methods,
?Direct quotation
?Indirect quotation
10.2 The Determination of The
Exchange Rate
? direct quotation,
? Using the domestic currency to represent the price of
foreign currency,such as ＄ 1＝ RMB￥ 8.2340。
? indirect quotation,
? Using foreign currency to represent the domestic price,
such as in England,￡ 1＝ DM2.4132。
? Although the two quotation methods of exchange rate
are different,they are reciprocal to each other in one
country,To A country,S(B/A) is the direct quotation，
then S(A/B) is the indirect quotation,
10.2 The Determination of The
Exchange Rate
? Quotations and the method of quoting price of
exchange rate
?Quoting price,
?Is the price willing to buy or sale the exchange
rate from the foreign exchange bank to other
banks and customers in a certain quotation
method,
10.2 The Determination of The
Exchange Rate
?International monetary system includes,fixed
exchange rate system and floating exchange
rate system,
10.2 The Determination of The
Exchange Rate
? Fixed exchange rate system means that the
relative price of the two countries’ currency is
fixed,its change boundary is restrained in a
certain range,including,
?fixed exchange rate system under the
international gold standard system
?Bretton Woods Conference system’s
adjustable fasten system
10.2 The Determination of The
Exchange Rate
? International gold standard system
? The monetary system before the World War one in
western countries；
? Gold currency is the standard currency that has infinite
ability to compensate,and can repay all of the debts；
? Gold currency can be melted and founded freely ; gold can
be transported freely ；
? The amount of the pure gold (quality and weight) per gold
currency is regulated by the law,；
? The bank security takes part in the circulation to freely
exchange with the gold as the representative of the gold
currency 。
10.2 The Determination of The
Exchange Rate
? Bretton Woods Conference monetary system
? The fixed exchange rate system established after the
world war two is dollar-centered and its basic content
can be abbreviated to, two connections” system：
dollar connects with the gold,other countries’
currency connects with the dollar,
? the exchange rate established by many countries’
currency and dollar is the law exchange rate,Foreign
exchange rate is affected by the demand and supply
and fluctuates up and down around the law exchange
rate,
10.2 The Determination of The
Exchange Rate
?Exchange rate and Purchasing Power Parity (PPP)——
in the long term
?Proposed by the Sweden economist Cassel；
?The change of the exchange rate is directly affected by the two
countries’ price；
?The rate of exchange between the two countries’ currencies is
determined by the two currencies’ real purchasing power；
?The change of the prices in two countries will be followed by the
change of the exchange rate of the two countries
10.2 The Determination of The
Exchange Rate
?The advantages and disadvantages of
the PPP
?advantages
?Purchasing power reflects the producing ability,If one country’s
producing ability increases continually,much higher than other
countries in a long period,then this country’s currency will
increase in value,
?disadvantages
?PPP is established through tradable goods,but in the reality
many goods and labor service are not tradable,Such as, tourism
?Different brands which have the same function are much
different in the price,so it is difficult to fix the exchange rate,
10.2 The Determination of The
Exchange Rate
?Exchange rate and Interest Rate Parity (IRP)
—— in the short term
?The aim to purchase and sale the foreign exchange is to get the
payoff,the higher the interest rate in one country is,the more
probable of high payoff,then people are willing to invest, All of
the funds should be calculated in domestic currency,
?The rise of the domestic interest rate can increase the national
financial market demand of the domestic currency,and the rise of
the currency demand can make the price or exchange rate rising,
EMR d ??
10.3 Floating Exchange Rate
System
?Floating exchange rate system means
the unfixed of the exchange rate
between one country and another
country’s currency,and freely fluctuate
according to the change between
demand and supply in the foreign
exchange market,
10.3 Floating Exchange Rate
System
?The determination of exchange rate under the
Floating exchange rate system,
?Under the floating exchange rate,the rate of
exchange is determined by the currency demand and
supply in the financial market,IRP theory。
?IRP indicates,the currency price in the
international financial market,namely exchange rate,
and the domestic currency price,namely interest rate,
are closely connected; meanwhile,it indicates the
change rule of the short-term exchange rate under
the floating exchange rate system,
10.3 Floating Exchange Rate
System
?The determination of the exchange rate
*P
PEmnYgNX ????
vRqPPE ??*
NXCFBP ??
)( *RRaCF ??
10.3 Floating Exchange Rate
System
according to the group of equations upwards,
*
* )(
P
PEmnYgRRa
NXCFBP
??????
??
10.3 Floating Exchange Rate
System
?The determination of the exchange rate
?conclusion,
?The income level and the National Income Account,inverse proportion；
?Interest rate and the National Income Account,uncertain
?The interest rate rises,the capital transfers to the homeland,the capital
account will have favorable balance ；
?The interest rate rises,the net export decreases,the current account will
have trade deficit；
?In industry countries,the financial market is mature,the speed of
international capital flow is higher than the speed of change in net
export,Thus,capital account plays the main role in balancing the whole
national income account,Thus the interest rate rises,the BP will have
surplus,
?In developing countries,whether these conclusions are suitable needs
confirmation,
10.3 Floating Exchange Rate
System
BP=0 BP>0
?The determination of the exchange rate
BP<0
R(%)
Y(GDP)
Ymva nmva mqgaRR ??? ???
*
10.4 Fixed Exchange Rate System
?Fixed exchange rate,Bretton Woods Conference（ 1944）
?sponsor,Keynes
?tenet,discussion about the world’s economic situation after the
Second War,
?result,determining the fixed exchange rate between industry
countries
?Advantages and disadvantages,
? advantages,economic recovery； relatively stable international
trade； relative low inflation rate in countries
? disadvantages,the monetary policy can not be very effective
illustrate,
country
A
enters
America
country
B
enters
Determine and keep
the country A’s currency
in the form of dollar
The relative currency price
between country A and country B
is fixed through dollar,
Change the dollar
into gold according
to the fixed price
Change the dollar
into gold according
to the fixed price
Determine and keep
the country A’s currency
in the form of dollar
10.4 Fixed Exchange Rate System
Fixed exchange rate,Bretton
Woods Conference（ 1944）
10.4 Fixed Exchange Rate System
?The character of the fixed exchange
rate
?The exchange rate E does not adjust
according to the interest rate
Y
a
n
a
P
P
mEgaR
R ?
??
?
*
*
BP=0
The higher the value of
the a,the difference
between domestic
and foreign interest
rate will make great
amount of capital
flow； the low value
of a indicates the
immaturity of the
financial market,the
capital flow has some
restrictions and
difficulties,the
difference of
domestic and foreign
interest rate cannot
cause great amount
of capital flow,
IS
LM
Y
E
BP=0
Y*
10.4 Fixed Exchange Rate System
10.4 Fixed Exchange Rate System
?example,
1
1
15.1
08.0
25.0
200
*
*
?
?
?
?
?
?
P
P
E
R
t
G
*
*
0
) 2000 8, 0 (
100 1, 0 195
1000 300,
) 1 (
8, 0 100
R R BP
P R Y M
P
P E Y NX
YI
t Y
Y C
NX G I C Y
d
d
? ?
? ?
? ? ?
? ?
? ?
? ?
? ? ? ?
s.t.,
Monetary market,
Net export,
Investment,
Governable
income,
Consumption,
Income,
10.4 Fixed Exchange Rate System
?Figure out from the above suppositions
800
08.0
1 2 0 0
*
*
?
?
?
M
R
Y
? IS-LM-BP model
under fixed
exchange rate
? Expansionary
fiscal policy
? Suppose that the
government
expenditure
increase from 2
million to
2.1million,pro-
ducts increase
from 12 million
to 12.2million
IS0
LM1
Y
E0 E1
IS1
BP=0
LM0
Fiscal
policy
10.4 Fixed Exchange Rate System
1200 1220
?IS-LM-BP
model under
floating
exchange rate
?Expansionary
fiscal policy
IS1
LM
Y
E1
E2
IS2
BP1=0
BP2=0
10.4 Fixed Exchange Rate System
10.4 Fixed Exchange Rate System
? The comparison between fixed exchange rate and floating
exchange rate
? Fixed exchange rate system,
?Monetary policy is restricted,fiscal policy effectively
works；
?Developing country can effectively use fiscal policy to
manage the economy。
? Floating exchange rate system,
?Monetary policy effectively works,the effectiveness
of fiscal policy decrease；
?Countries with mature financial market all use the
floating exchange rate system,because giving up the
monetary policy will weaken the function of market
economy。
10.5 Trade Environment and
Trade Policy
? Trade environment
? Closely connected with the country’s economic
development
? Capital-densed country,monopolize the market price，
high-tech and capital-densed products have high price in
the international market,and can monopolize the profit
through the trade policy,
? Labor-densed country：,competing market price”,labor-
densed products’ price are all very cheap in the
international market,
? Changing the trade structure is very important to the
country’s economic development,
10.5 Trade Environment and
Trade Policy
? Trade protection policy
?Policy in order to restrict the import
?Tariff wall
?Import quota
?Policy encouraging the export
?Export allowance
10.5 Trade Environment and
Trade Policy
?The integration of the world economy
?Trade protection policy decreases；
?Trade policy is still the supplement of the
market mechanism,
?Protecting the market share and support
the high-tech industry are indispensable to
the developing country,
10.5 Trade Environment and
Trade Policy
?International capital flow
?Influence factors,the interest rate and
economy,politics and society factors；
?Differences among countries,the
interest rate in developing country is
higher than the developed country,but
only a small amount of international
capital flow can flow into the developing
countries,The reason is that,investors
think about not only the profit but also
the security,
10.6 The Summary of Open
Economy Equilibrium
? Balance of Payment (BP) is the function of interest rate,exchange rate and
gross income level
? Floating exchange rate and fixed exchange rate
? Under floating exchange rate,exchange rat is determined by the demand
and supply of the foreign exchange market,the long-term trend of the rate of
the exchange is determined by the Purchasing Power Parity between
exchange rate and purchasing power,and in the short term by the exchange
rate and the Interest Rate Parity” ;balance of payments is the function of
interest,In the plane of R-Y,BP=0 can divide the whole plane into surplus
and deficit,The equilibrium of the whole demand need both the equilibrium
of the goods market and the equilibrium of the monetary equilibrium.。
? Under fixed exchange rate,exchange rate is determined by the government,
and has no direct connection with the interest rate,With the great amount of
capital flow,the BP line will become a horizontal line,The equilibrium point is
determined by the IS line and horizontal line,The center bank can only
adjust the supply of the currency to keep the domestic interest rate and
foreign interest rate,The fiscal policy is very effective,
10.6 The Summary of Open
Economy Equilibrium
Production function y=y (N,K)
—
Equilibrium in the
labour market
Nd=Nd(W/P),W
Equilibrium in goods
market I(r)+G+x(P,e)=s(y-t)+T+m(y,P,e)
Equilibrium in monetary
market M/P= L= L1(y) +L2(r)
Balance of payments x(P,e)-m(y,P,e)=F(r)
y,r
,P,N
和e
Production function y=y (N,K)
—
Equilibrium in the
labour market Ns(W/P)=Nd(W/P)
Equilibrium in goods
market I(r)+G+x(P,e)=s(y-t)+T+m(y,P,e)
Equilibrium in
monetary market M/P= L= L1(y) +L2(r)
Balance of payments x(P,e)-m(y,P,e)=F(r)
y,
r,P
,N
和e
Sh
ort
-te
rm
su
pp
ly
cur
ve
L
on
g-t
erm
su
pp
ly
cu
rve
Chapter 10
The End
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
Open Economy
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
Topics to be Discussed
? National Income Accounting and the
Balance of Payments & other concepts
? The determination of exchange rate
? floating exchange rate system
? Fixed exchange rate system
? Trade environment and policy
? Summary of the open economy
10.1 National Income Accounting and
the Balance of Payments & Other
Concepts
? Balance of Payment, recording the financial
capital debit and credit,purchases or sales of
investment assets, exports or imports of goods
or services,etc,Balance of payments include
capital account,current account and balance
account,
? The Balance of Payments Accounts, a
systematical report forms of all economic
transactions in a period,including current item、
capital item and balance item,
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
? Current item,or goods and labor services item,including,goods
(imports and exports); labor services,such as,transportation、
insurance, traveling, investment labor services (interest,
dividend, profit) and other labor ； international unilateral
transfer,such as religion,charity,donation to the education、
non-war reparations,etc,
? Capital item,all of the exchange activities facing exterior capital
and debts,such as investment, stocks and bond trading,etc,
? Official repertory item, the exterior net trading of national
currency department,including gold, foreign exchange
repertory,etc,If the credit is larger than the debit,then the item
will increase; otherwise,if the debit is larger than the credit,then
the item will decrease,
? Error item,balance through this item if the credit does equal to
the debit,
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
)( *RRaCF ??
?Capital account,recording international investment and debit and
credit,International investment includes the foreign real estate, foreign
corporations’ stocks, foreign governments’ bonds of individual、
corporation and government,and the domestic real estate,stocks and
government bonds purchased by the foreign individual,corporations
and governments,International debit and credit includes the domestic
corporation and government’ loan get from foreign bank,fund and
governments,and the funds lent by the foreign corporations and
governments,Capital mobility is defined CF,R is domestic interest,R* is
the foreign interest,a is the coefficient,then,
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
?Current account,mainly be used to record the total
amount of imports and exports in goods and services,
Including Net Export,Investment Income,Transfer
Payment,Defining that the NX is the net export,Y is
the national income,E is the nominal exchange rate,
P is the domestic price,P*is the foreign price,then,
*P
PEmnYgNX ????
10.1 National Income Accounting and the
Balance of Payments & Other Concepts
?Because the Balance of Payments (BP） can be abbreviated to
capital mobility and net export,then,
*
* )(
P
P
EmnYgRRa
NXCFBP
??????
??
10.2 The Determination of The
Exchange Rate
? Exchange rate is the relative price of the
domestic currency and the foreign currency,
and plays an important role in the international
economic activities,
? The change of the exchange rate can directly
affect the net export,
? The exchange rate can affect the domestic
gross demand through the net export,
10.2 The Determination of The
Exchange Rate
?A highly-abbreviated model
?There are only two countries in the world,one is China,
the other is Canada; They only produce one product,
corn,people consume corn,and use it to invest（
seeds),government uses corn to pay,If the price of corn
is 1yuan per kilogram in China,1 Canadian dollar per
kilogram in Canada。 Then the rate of exchange of RMB
to Canadian dollar should be？
1,1 namely1RMB exchange
1Canadian dollar
10.2 The Determination of The
Exchange Rate
?Suppose that if the price of corn in China is 2yuan per
kilogram,and 1Canadian dollar per kilogram in Canada,Then
what should the rate of exchange from RMB to Canadian dollar
be？ 2:1 namely 2yuan RMB
exchanges1Canadian dollars
?Otherwise,if the price of corn in Canada rise to 2yuanRMB
per kilogram,and 1Canadian dollar per kilogram in China,
Then what should the rate of exchange from RMB to Canadian
dollar be？
1:2namely 1yuan RMB exchange 2
Canadian dollars
10.2 The Determination of The
Exchange Rate
?conclusion,exchange rate is determined by the
price of the two countries,The price of one country
rise,its currency will be depreciated; vice versa,
10.2 The Determination of The
Exchange Rate
? Quotations and the method of quoting price of
exchange rate
? quotations,
?Use some currency as the standards of
other currencies when weighing the price,
?Because the market of exchange rate can
be divided into wholesale market between
the international banks and the retail
market between bank and customers I,
then the method of quotation is different,
10.2 The Determination of The
Exchange Rate
? Quotations and the method of quoting price of
exchange rate
?Two methods,
?Direct quotation
?Indirect quotation
10.2 The Determination of The
Exchange Rate
? direct quotation,
? Using the domestic currency to represent the price of
foreign currency,such as ＄ 1＝ RMB￥ 8.2340。
? indirect quotation,
? Using foreign currency to represent the domestic price,
such as in England,￡ 1＝ DM2.4132。
? Although the two quotation methods of exchange rate
are different,they are reciprocal to each other in one
country,To A country,S(B/A) is the direct quotation，
then S(A/B) is the indirect quotation,
10.2 The Determination of The
Exchange Rate
? Quotations and the method of quoting price of
exchange rate
?Quoting price,
?Is the price willing to buy or sale the exchange
rate from the foreign exchange bank to other
banks and customers in a certain quotation
method,
10.2 The Determination of The
Exchange Rate
?International monetary system includes,fixed
exchange rate system and floating exchange
rate system,
10.2 The Determination of The
Exchange Rate
? Fixed exchange rate system means that the
relative price of the two countries’ currency is
fixed,its change boundary is restrained in a
certain range,including,
?fixed exchange rate system under the
international gold standard system
?Bretton Woods Conference system’s
adjustable fasten system
10.2 The Determination of The
Exchange Rate
? International gold standard system
? The monetary system before the World War one in
western countries；
? Gold currency is the standard currency that has infinite
ability to compensate,and can repay all of the debts；
? Gold currency can be melted and founded freely ; gold can
be transported freely ；
? The amount of the pure gold (quality and weight) per gold
currency is regulated by the law,；
? The bank security takes part in the circulation to freely
exchange with the gold as the representative of the gold
currency 。
10.2 The Determination of The
Exchange Rate
? Bretton Woods Conference monetary system
? The fixed exchange rate system established after the
world war two is dollar-centered and its basic content
can be abbreviated to, two connections” system：
dollar connects with the gold,other countries’
currency connects with the dollar,
? the exchange rate established by many countries’
currency and dollar is the law exchange rate,Foreign
exchange rate is affected by the demand and supply
and fluctuates up and down around the law exchange
rate,
10.2 The Determination of The
Exchange Rate
?Exchange rate and Purchasing Power Parity (PPP)——
in the long term
?Proposed by the Sweden economist Cassel；
?The change of the exchange rate is directly affected by the two
countries’ price；
?The rate of exchange between the two countries’ currencies is
determined by the two currencies’ real purchasing power；
?The change of the prices in two countries will be followed by the
change of the exchange rate of the two countries
10.2 The Determination of The
Exchange Rate
?The advantages and disadvantages of
the PPP
?advantages
?Purchasing power reflects the producing ability,If one country’s
producing ability increases continually,much higher than other
countries in a long period,then this country’s currency will
increase in value,
?disadvantages
?PPP is established through tradable goods,but in the reality
many goods and labor service are not tradable,Such as, tourism
?Different brands which have the same function are much
different in the price,so it is difficult to fix the exchange rate,
10.2 The Determination of The
Exchange Rate
?Exchange rate and Interest Rate Parity (IRP)
—— in the short term
?The aim to purchase and sale the foreign exchange is to get the
payoff,the higher the interest rate in one country is,the more
probable of high payoff,then people are willing to invest, All of
the funds should be calculated in domestic currency,
?The rise of the domestic interest rate can increase the national
financial market demand of the domestic currency,and the rise of
the currency demand can make the price or exchange rate rising,
EMR d ??
10.3 Floating Exchange Rate
System
?Floating exchange rate system means
the unfixed of the exchange rate
between one country and another
country’s currency,and freely fluctuate
according to the change between
demand and supply in the foreign
exchange market,
10.3 Floating Exchange Rate
System
?The determination of exchange rate under the
Floating exchange rate system,
?Under the floating exchange rate,the rate of
exchange is determined by the currency demand and
supply in the financial market,IRP theory。
?IRP indicates,the currency price in the
international financial market,namely exchange rate,
and the domestic currency price,namely interest rate,
are closely connected; meanwhile,it indicates the
change rule of the short-term exchange rate under
the floating exchange rate system,
10.3 Floating Exchange Rate
System
?The determination of the exchange rate
*P
PEmnYgNX ????
vRqPPE ??*
NXCFBP ??
)( *RRaCF ??
10.3 Floating Exchange Rate
System
according to the group of equations upwards,
*
* )(
P
PEmnYgRRa
NXCFBP
??????
??
10.3 Floating Exchange Rate
System
?The determination of the exchange rate
?conclusion,
?The income level and the National Income Account,inverse proportion；
?Interest rate and the National Income Account,uncertain
?The interest rate rises,the capital transfers to the homeland,the capital
account will have favorable balance ；
?The interest rate rises,the net export decreases,the current account will
have trade deficit；
?In industry countries,the financial market is mature,the speed of
international capital flow is higher than the speed of change in net
export,Thus,capital account plays the main role in balancing the whole
national income account,Thus the interest rate rises,the BP will have
surplus,
?In developing countries,whether these conclusions are suitable needs
confirmation,
10.3 Floating Exchange Rate
System
BP=0 BP>0
?The determination of the exchange rate
BP<0
R(%)
Y(GDP)
Ymva nmva mqgaRR ??? ???
*
10.4 Fixed Exchange Rate System
?Fixed exchange rate,Bretton Woods Conference（ 1944）
?sponsor,Keynes
?tenet,discussion about the world’s economic situation after the
Second War,
?result,determining the fixed exchange rate between industry
countries
?Advantages and disadvantages,
? advantages,economic recovery； relatively stable international
trade； relative low inflation rate in countries
? disadvantages,the monetary policy can not be very effective
illustrate,
country
A
enters
America
country
B
enters
Determine and keep
the country A’s currency
in the form of dollar
The relative currency price
between country A and country B
is fixed through dollar,
Change the dollar
into gold according
to the fixed price
Change the dollar
into gold according
to the fixed price
Determine and keep
the country A’s currency
in the form of dollar
10.4 Fixed Exchange Rate System
Fixed exchange rate,Bretton
Woods Conference（ 1944）
10.4 Fixed Exchange Rate System
?The character of the fixed exchange
rate
?The exchange rate E does not adjust
according to the interest rate
Y
a
n
a
P
P
mEgaR
R ?
??
?
*
*
BP=0
The higher the value of
the a,the difference
between domestic
and foreign interest
rate will make great
amount of capital
flow； the low value
of a indicates the
immaturity of the
financial market,the
capital flow has some
restrictions and
difficulties,the
difference of
domestic and foreign
interest rate cannot
cause great amount
of capital flow,
IS
LM
Y
E
BP=0
Y*
10.4 Fixed Exchange Rate System
10.4 Fixed Exchange Rate System
?example,
1
1
15.1
08.0
25.0
200
*
*
?
?
?
?
?
?
P
P
E
R
t
G
*
*
0
) 2000 8, 0 (
100 1, 0 195
1000 300,
) 1 (
8, 0 100
R R BP
P R Y M
P
P E Y NX
YI
t Y
Y C
NX G I C Y
d
d
? ?
? ?
? ? ?
? ?
? ?
? ?
? ? ? ?
s.t.,
Monetary market,
Net export,
Investment,
Governable
income,
Consumption,
Income,
10.4 Fixed Exchange Rate System
?Figure out from the above suppositions
800
08.0
1 2 0 0
*
*
?
?
?
M
R
Y
? IS-LM-BP model
under fixed
exchange rate
? Expansionary
fiscal policy
? Suppose that the
government
expenditure
increase from 2
million to
2.1million,pro-
ducts increase
from 12 million
to 12.2million
IS0
LM1
Y
E0 E1
IS1
BP=0
LM0
Fiscal
policy
10.4 Fixed Exchange Rate System
1200 1220
?IS-LM-BP
model under
floating
exchange rate
?Expansionary
fiscal policy
IS1
LM
Y
E1
E2
IS2
BP1=0
BP2=0
10.4 Fixed Exchange Rate System
10.4 Fixed Exchange Rate System
? The comparison between fixed exchange rate and floating
exchange rate
? Fixed exchange rate system,
?Monetary policy is restricted,fiscal policy effectively
works；
?Developing country can effectively use fiscal policy to
manage the economy。
? Floating exchange rate system,
?Monetary policy effectively works,the effectiveness
of fiscal policy decrease；
?Countries with mature financial market all use the
floating exchange rate system,because giving up the
monetary policy will weaken the function of market
economy。
10.5 Trade Environment and
Trade Policy
? Trade environment
? Closely connected with the country’s economic
development
? Capital-densed country,monopolize the market price，
high-tech and capital-densed products have high price in
the international market,and can monopolize the profit
through the trade policy,
? Labor-densed country：,competing market price”,labor-
densed products’ price are all very cheap in the
international market,
? Changing the trade structure is very important to the
country’s economic development,
10.5 Trade Environment and
Trade Policy
? Trade protection policy
?Policy in order to restrict the import
?Tariff wall
?Import quota
?Policy encouraging the export
?Export allowance
10.5 Trade Environment and
Trade Policy
?The integration of the world economy
?Trade protection policy decreases；
?Trade policy is still the supplement of the
market mechanism,
?Protecting the market share and support
the high-tech industry are indispensable to
the developing country,
10.5 Trade Environment and
Trade Policy
?International capital flow
?Influence factors,the interest rate and
economy,politics and society factors；
?Differences among countries,the
interest rate in developing country is
higher than the developed country,but
only a small amount of international
capital flow can flow into the developing
countries,The reason is that,investors
think about not only the profit but also
the security,
10.6 The Summary of Open
Economy Equilibrium
? Balance of Payment (BP) is the function of interest rate,exchange rate and
gross income level
? Floating exchange rate and fixed exchange rate
? Under floating exchange rate,exchange rat is determined by the demand
and supply of the foreign exchange market,the long-term trend of the rate of
the exchange is determined by the Purchasing Power Parity between
exchange rate and purchasing power,and in the short term by the exchange
rate and the Interest Rate Parity” ;balance of payments is the function of
interest,In the plane of R-Y,BP=0 can divide the whole plane into surplus
and deficit,The equilibrium of the whole demand need both the equilibrium
of the goods market and the equilibrium of the monetary equilibrium.。
? Under fixed exchange rate,exchange rate is determined by the government,
and has no direct connection with the interest rate,With the great amount of
capital flow,the BP line will become a horizontal line,The equilibrium point is
determined by the IS line and horizontal line,The center bank can only
adjust the supply of the currency to keep the domestic interest rate and
foreign interest rate,The fiscal policy is very effective,
10.6 The Summary of Open
Economy Equilibrium
Production function y=y (N,K)
—
Equilibrium in the
labour market
Nd=Nd(W/P),W
Equilibrium in goods
market I(r)+G+x(P,e)=s(y-t)+T+m(y,P,e)
Equilibrium in monetary
market M/P= L= L1(y) +L2(r)
Balance of payments x(P,e)-m(y,P,e)=F(r)
y,r
,P,N
和e
Production function y=y (N,K)
—
Equilibrium in the
labour market Ns(W/P)=Nd(W/P)
Equilibrium in goods
market I(r)+G+x(P,e)=s(y-t)+T+m(y,P,e)
Equilibrium in
monetary market M/P= L= L1(y) +L2(r)
Balance of payments x(P,e)-m(y,P,e)=F(r)
y,
r,P
,N
和e
Sh
ort
-te
rm
su
pp
ly
cur
ve
L
on
g-t
erm
su
pp
ly
cu
rve
Chapter 10
The End
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