Chapter 6:Openness in Goods
and Financial Market
6-1:Openness in Goods Market
6-2:Openness in Financial Market
6-3:Conclusions and a Look ahead
6-1:Openness in Goods
Market
The Choice between Domestic and
Foreign Goods
? Nominal Exchange Rates
? Real Exchange Rates
6-1:Openness in Goods
Market
Table 18-1:Ratios of Exports to GDP for Selected OECD
Countries,1997
Country Export Ratio Country Export Ratio
United States 12% Switzerland 40%
Japan 10% Austria 38%
Germany 23% Belgium 73%
United Kingdom 29% Luxembourg 91%
Appendix,The Sum of Trade and
Proportion in GDP
Year SUM
(RMB)
Proportion
In GDP(%)
Year SUM
(RMB)
Proportion
In GDP(%)
1978 355.0 9.8 1995 23499.9 40.2
1980 570.0 12.6 1996 24133.8 35.6
1985 2066.7 23.1 1997 26967.2 36.2
1990 5560.1 30.0 1998 26857.7 34.3
1991 7225.8 33.4 1999 26896.3 32.8
1992 9119.6 34.2 2000 35368.6 40.1
1993 11271.0 32.5 2001 38021.3 39.6
1994 20381.9 43.6 2002 46309.9 45.2
Nominal Exchange Rates
From the Point of View of United States
Looking at Germany
Nominal exchange rate E
Price of DM in terms of dollars
Appreciation of the dollar
Price of dollars in DM increases equivalently:
price of DM in dollars decreases equivalently:
Exchange rate decreases:E↓
Depreciation of the dollar
Price of dollars in DM decreases equivalently:
price of DM in dollars increases equivalently:
Exchange rate increases:E↑
Real Exchange Rate
Price of German
goods in DM
P*
Price of German
goods in dollars
EP*
Price of U.S
goods in dollars
P
Real
Exchange rate
ε =EP*/P
Figure:The Country Composition
of U.S,Merchandise Trade,1998
Exports to Imports from
Countries $Billions Percent $Billions Percent
Canada 156 23 177 19
Western Europe 159 24 193 21
Japan 57 8 121 13
Mexico 78 12 95 11
Asia 126 19 247 27
OPEC 15 2 19 2
Others 80 11 67 7
Total 671 100 919 100
Fr om th e po int o f view of U n ited S tat ed
L o o k i n g a t G e r m a n y
R eal e x cha n ge rate ε
P rice of G erm an good s in t erm s of U,S,goo ds
R eal app r eci ation
P rice of U,S,goo ds in t erm s of G erm any goo ds incre ases
E q u i v a l e n t l y,
P rice of G erm an g ood s in t erm s of U,S, goo ds decrea s es
E quivalently,
R ea l exc hange rate decrea s es,ε
Re al depr ec iat ion
P rice of U,S, goo ds in t erm s of G erm any goo ds decrea s es
E q u i v a l e n t l y,
P rice of G erm an good s in t erm s of U,S, goo ds incre ases
E quival ently,
R ea l exc hange rate incre ases, ε
6-2:Openness in Financial
Market
The Balance of Payments
? The Current Account
? The Capital Account
The Choice between Domestic and
Foreign Assets
Figure The U.S,Balance of
Payments,1998,in Billions of U.S,Dollars
Current Account
Exports 931
Imports 1100
Trade balance(deficit= -) (1) -169
Investment income received 242
Investment income paid 265
Net investment income (2) -23
Net transfers received (3) -41
Current account balance (deficit = -) (1)+(2)+(3) -233
Capital Account
Increase in foreign holdings of U.S,assets 542
Increase in U.S,holdings of foreign assets 305
Net increase in foreign holdings/(net capital flows to the U.S,237
Statistical discrepancy 4
Expected Returns from Holding
One-Year U.S,or German Bonds
Y ea r t Y ea r t+1
U,S,bond s $1 $(1+i
t
)
Ge rm an bond s $1 $(
t
E
1
)( 1+i
t
*
)E
t + 1
e
D M (
t
E
1
) DM (
t
E
1
)( 1+ i
t
*
)
1+i
t
= (1+i
t
*
)(
t
e
t
E
E
1?
) (6.2 )
1+i
t
= (1+i
t
*
)(1+
t
t
e
t
E
EE ?
? 1
) (6.3 )
i
t
= i
t
*
+
t
t
e
t
E
EE ?
? 1
(6.4 )
Summary
Openness in goods markets allows people and firms to choose between
domestic and foreign goods,Openness in financial markets allows financial
investors to choose between domestic or foreign financial assets.
The nominal exchange rate is the price of foreign currency in terms of domestic
currency,From the viewpoint of the United States,the nominal exchange rate
between the United States and Germany is the price of DM in terms of dollars.
A nominal appreciation is an increase in the price of the domestic currency in
terms of foreign currency; given the definition of the exchange rate,A nominal
depreciation is a decrease in the price of the domestic currency in terms of
foreign currency; it corresponds to an increase in the exchange rate.
The real exchange rate is the relative price of foreign goods in terms of domestic
goods; it is equal to the nominal exchange rate times the foreign price level
divided by the domestic price level.
and Financial Market
6-1:Openness in Goods Market
6-2:Openness in Financial Market
6-3:Conclusions and a Look ahead
6-1:Openness in Goods
Market
The Choice between Domestic and
Foreign Goods
? Nominal Exchange Rates
? Real Exchange Rates
6-1:Openness in Goods
Market
Table 18-1:Ratios of Exports to GDP for Selected OECD
Countries,1997
Country Export Ratio Country Export Ratio
United States 12% Switzerland 40%
Japan 10% Austria 38%
Germany 23% Belgium 73%
United Kingdom 29% Luxembourg 91%
Appendix,The Sum of Trade and
Proportion in GDP
Year SUM
(RMB)
Proportion
In GDP(%)
Year SUM
(RMB)
Proportion
In GDP(%)
1978 355.0 9.8 1995 23499.9 40.2
1980 570.0 12.6 1996 24133.8 35.6
1985 2066.7 23.1 1997 26967.2 36.2
1990 5560.1 30.0 1998 26857.7 34.3
1991 7225.8 33.4 1999 26896.3 32.8
1992 9119.6 34.2 2000 35368.6 40.1
1993 11271.0 32.5 2001 38021.3 39.6
1994 20381.9 43.6 2002 46309.9 45.2
Nominal Exchange Rates
From the Point of View of United States
Looking at Germany
Nominal exchange rate E
Price of DM in terms of dollars
Appreciation of the dollar
Price of dollars in DM increases equivalently:
price of DM in dollars decreases equivalently:
Exchange rate decreases:E↓
Depreciation of the dollar
Price of dollars in DM decreases equivalently:
price of DM in dollars increases equivalently:
Exchange rate increases:E↑
Real Exchange Rate
Price of German
goods in DM
P*
Price of German
goods in dollars
EP*
Price of U.S
goods in dollars
P
Real
Exchange rate
ε =EP*/P
Figure:The Country Composition
of U.S,Merchandise Trade,1998
Exports to Imports from
Countries $Billions Percent $Billions Percent
Canada 156 23 177 19
Western Europe 159 24 193 21
Japan 57 8 121 13
Mexico 78 12 95 11
Asia 126 19 247 27
OPEC 15 2 19 2
Others 80 11 67 7
Total 671 100 919 100
Fr om th e po int o f view of U n ited S tat ed
L o o k i n g a t G e r m a n y
R eal e x cha n ge rate ε
P rice of G erm an good s in t erm s of U,S,goo ds
R eal app r eci ation
P rice of U,S,goo ds in t erm s of G erm any goo ds incre ases
E q u i v a l e n t l y,
P rice of G erm an g ood s in t erm s of U,S, goo ds decrea s es
E quivalently,
R ea l exc hange rate decrea s es,ε
Re al depr ec iat ion
P rice of U,S, goo ds in t erm s of G erm any goo ds decrea s es
E q u i v a l e n t l y,
P rice of G erm an good s in t erm s of U,S, goo ds incre ases
E quival ently,
R ea l exc hange rate incre ases, ε
6-2:Openness in Financial
Market
The Balance of Payments
? The Current Account
? The Capital Account
The Choice between Domestic and
Foreign Assets
Figure The U.S,Balance of
Payments,1998,in Billions of U.S,Dollars
Current Account
Exports 931
Imports 1100
Trade balance(deficit= -) (1) -169
Investment income received 242
Investment income paid 265
Net investment income (2) -23
Net transfers received (3) -41
Current account balance (deficit = -) (1)+(2)+(3) -233
Capital Account
Increase in foreign holdings of U.S,assets 542
Increase in U.S,holdings of foreign assets 305
Net increase in foreign holdings/(net capital flows to the U.S,237
Statistical discrepancy 4
Expected Returns from Holding
One-Year U.S,or German Bonds
Y ea r t Y ea r t+1
U,S,bond s $1 $(1+i
t
)
Ge rm an bond s $1 $(
t
E
1
)( 1+i
t
*
)E
t + 1
e
D M (
t
E
1
) DM (
t
E
1
)( 1+ i
t
*
)
1+i
t
= (1+i
t
*
)(
t
e
t
E
E
1?
) (6.2 )
1+i
t
= (1+i
t
*
)(1+
t
t
e
t
E
EE ?
? 1
) (6.3 )
i
t
= i
t
*
+
t
t
e
t
E
EE ?
? 1
(6.4 )
Summary
Openness in goods markets allows people and firms to choose between
domestic and foreign goods,Openness in financial markets allows financial
investors to choose between domestic or foreign financial assets.
The nominal exchange rate is the price of foreign currency in terms of domestic
currency,From the viewpoint of the United States,the nominal exchange rate
between the United States and Germany is the price of DM in terms of dollars.
A nominal appreciation is an increase in the price of the domestic currency in
terms of foreign currency; given the definition of the exchange rate,A nominal
depreciation is a decrease in the price of the domestic currency in terms of
foreign currency; it corresponds to an increase in the exchange rate.
The real exchange rate is the relative price of foreign goods in terms of domestic
goods; it is equal to the nominal exchange rate times the foreign price level
divided by the domestic price level.
