Garantie de satisfaction à 100% Disponible immédiatement après paiement En ligne et en PDF Tu n'es attaché à rien
logo-home
Recherché précédemment par vous
Recherché précédemment par vous
logo
HT4 Open Economy Notes $7.39
Ajouter au panier
Accédez rapidement à
Aperçu
  2.  
  3. University Of Oxford
  4.  
  5. Macroeconomics

Notes de cours

HT4 Open Economy Notes
 0 fois vendu
  • Cours
  • Macroeconomics
  • Établissement
  • University Of Oxford

These notes were prepared based on the lectures and supplemented by information from textbooks and tutorials where parts of the lecture were unclear. Graphs, equations, and bullet-point explanations included. Prepared by a first class Economics and Management student for the FHS Macroeconomics pape...

[Montrer plus]

Aperçu 4 sur 36  pages

Infos sur le Document

  • 27 juin 2024
  • 36
  • 2022/2023
  • Notes de cours
  • -
  • Ht4 open economy

Sujets

  • open economy
  • is pc mr
  • inflation shock
  • ad shock
  • exchange rate overshooting

École, étude et sujet

  • University of Oxford
  • Inconnu
  • Macroeconomics
Tous les documents sur ce sujet (19)

Vendeur

avatar-seller
ib45pointer

Avis reçus

Aperçu du contenu

HT4 Macroecons (Open Economy)
Week's outline
 Lecture 9
o Modelling the Foreign Exchange market (3 arbitrage conditions)
o The AD side – 3 equation model in open economy
 Lecture 10
o Policy reactions in open economy
o Inflation shocks and AD shocks
o Overshooting of exchange rates
 Lecture 11
o The AS side
o Current Account deviations from equilibrium

Lecture 9: FX market in the Open Economy
Introduction: the open economy
What is different in an open economy?
 We have a new market (Foreign Exchange, FX) and a new price to clear it (exchange rate: e)
o Mediates buying/selling foreign (domestic) currency (money), goods and financial assets
 Dynamics of the real exchange rate q are of great importance
o The real exchange rate varies in the medium-run equilibrium in response to permanent
aggregate demand and supply shocks
o In a closed economy, the real interest rate r plays this key role
 The CB chooses the deviation of the interest rate r from the world interest rate r*, in the
dynamic adjustment of the economy to shocks
o (r – r*) as opposed to just r as in a closed economy
 Output y responds both to changes in r and to the associated changes in q
o FX market does part of the job of the CB
 In practice, these open economy issues are particularly important for smaller economies,
compared to larger economies (eg. US, China)

2 stabilization channels in open economy
 2 stabilization channels: the interest rate & exchange rate channels.
o Shock → 𝜋 > 𝜋𝑇→ CB raises 𝑖 → negative 𝑦-gap → 𝜋↓
o Also, FX market expects 𝑖↑ → returns to home bonds↑ (arbitrage opportunity) →
currency appreciates → Exports & AD↓ → 𝜋↓
 In addition to the interest rate channel that we studied in the closed economy, we have the
exchange rate channel
o Hence, CB raises 𝑖 by less than the closed economy case (since the exchange rate
channel helps stabilise the economy as well)
 Key Assumption: CB and FX market form expectations rationally
o Reality: while forex markets may be generally rational due to sophisticated financial
investors, it is still prone to fads and manias
o If not well-behaved, FX market may not be stabilising
 Before the era of high international capital mobility, FX was driven by trade

, o Now, the FX market is dominated by international financial markets
o The key determinant of exchange rate fluctuations is now the buying and selling of
currencies to trade in government bonds of different countries

International Financial Markets- Simplifying Assumptions
 Perfect international capital mobility (between countries, currencies)
 Small home country
o Any action does not affect the world interest rates (global variables can be treated as a
constant and independent of our actions)
 Households can hold 2 assets:
o Bonds (home & foreign) and money.
 Perfect substitutability between home and foreign bonds
o Only difference between bonds is expected return, they have the same default risk
o *If the default risk difference between countries' bonds is constant over time, our
analysis would not be affected

Modelling the FX market
 Does arbitrage equalize prices for the same good in different countries?
 How do traders decide on home and foreign assets?
 Answers: Three parity conditions
o 1. Purchasing Power Parity (PPP)
o 2. Covered Interest Parity (CIP)
o 3. Uncovered Interest Parity (UIP)
 Dornbusch’s overshooting of exchange rates
o The overshooting model argues that the foreign exchange rate will temporarily
overreact to changes in monetary policy to compensate for sticky prices of goods in the
economy (more later)

Exchange rates and pricing
The Nominal Exchange Rate
 Definition: Nominal exchange rate (E)

o
 An increase in E corresponds to a depreciation of home currency

o Home currency becomes less valuable- more units of home currency to buy one unit of
foreign currency
o Think of foreign currencies as goods bought domestically
o *Be careful: some textbooks may have a different definition where increase in E is
appreciation
 Convention: 𝑒 ≡ ln(𝐸)

The Real Exchange Rate
 Nominal exchange rates do not account for differences in prices between two countries
o Eg. USD/GBP = 0.74, €/GBP = 0.89 does not necessarily mean that America is cheaper
than Europe for a Brit

,  The real exchange rate is a measure of relative purchasing power

o
o P*: the foreign price level
o P: the domestic price level
o Obtain RHS by taking logarithm (ln) of both sides. Small letters indicate ln(.)
o Therefore, increase in Q or q (the real exchange rate) is a depreciation
 It’s also a measure of relative price competitiveness

o
o Terms of trade (TOT) represent the ratio between a country's export prices (P) and its
import prices (P* E)
o A higher TOT means export prices are higher than import prices:
 It means that the country can sell its products on the world market, receiving
more import good units for one unit of its export good
 Domestic products are thus deemed so attractive – and thus competitive – by
consumers abroad that they are willing to pay an increasing price.
o Therefore, an economy can be considered internationally competitive if it succeeds in
selling its products on the world market without the Terms of Trade deteriorating. And
when the Terms of Trade improve, the competitiveness of the economy increases.

Competitiveness and pricing rules
 Home-cost pricing: exporters set prices based on domestic costs (in home currency)
o Eg. BMW setting prices based on costs in Germany (depreciation of GBP relative to EUR
would increase BMW nominal prices in UK and make them less attractive to buyers)
 World-pricing: exporters set prices to match competitors’ abroad (in foreign currency)
o Chinese apparel exporters
 Implication of a ↑ domestic costs:
o Home-cost: ↑𝑃, ↓𝑄
 Higher domestic costs, higher price set, real appreciation of goods prices
(decrease in real exchange rate Q), loss of competitiveness
o World-pricing: price and real exchange rate unaffected
 No apparent loss of competitiveness as domestic cost increase is absorbed by
exporters (squeezes their margins) who set prices matching overseas
competitors that are not affected by the domestic cost increase
 Better measure: relative unit labour costs (RULC)

o
o If firms adopt world-pricing, looking at relative costs rather than prices could be more
insightful as a definition of real exchange rate
o Loss of competitiveness for most European countries (excluding Germany) as their RULC
decreased (foreign labour cheaper) while that of Germany (red line) stayed high (foreign
labour more expensive)

,  The diagram below uses a different definition of RULC (the reciprocal) so
Germany is low and other European countries is high




o

Three Parity Conditions
Purchasing Power Parity (PPP)
 Consequence of arbitrage in international market for goods/ services
o Traded Goods: goods with high value-to-transportation costs (eg. Cars, crude oil)
o Non-traded Goods: goods with low value-to-transportation costs (eg. Haircuts, water)
 Do not have their prices arbitraged due to high transportation costs to do so
 Law of One Price (LOP): Traded Goods should have the same price irrespective of location (so
real exchange rate 𝑄 = 1)
o 𝑃 = 𝑃*𝐸; 𝑄 = 1
o Implies Absolute Purchasing Power Parity if LOP applies to all goods
o Theoretically, the action of arbitrage should work to move prices so that they are
consistent with LOP
o In practice, LOP will only work if we are able to exclude transportation costs, tariffs,
taxes, and other location-specific outlays.
 Absolute PPP
o Price of baskets of goods are equal across countries, so the exchange rate between the
two nations will be equal to the ratio of the price levels for those two countries.
o It never applies in practice:
 Only traded goods are arbitraged
 Different basket of goods in CPI across countries (so even if LOP holds, if we use
CPI as a proxy for price levels, Q ≠ 1)
 Exploitation of local market power distort pricing etc.
o Absolute PPP for all goods implies 𝑄 = 1. If there is perfect competition (p = MC), then
all MC in all countries is also equal (unlike the world-pricing hypothesis where costs can
differ across countries and profit margins expand and contract)
 Relative PPP
o
 Nominal exchange rate percentage changes equal to the difference in inflation
rates

Les avantages d'acheter des résumés chez Stuvia:

Qualité garantie par les avis des clients

Qualité garantie par les avis des clients

Les clients de Stuvia ont évalués plus de 700 000 résumés. C'est comme ça que vous savez que vous achetez les meilleurs documents.

L’achat facile et rapide

L’achat facile et rapide

Vous pouvez payer rapidement avec iDeal, carte de crédit ou Stuvia-crédit pour les résumés. Il n'y a pas d'adhésion nécessaire.

Focus sur l’essentiel

Focus sur l’essentiel

Vos camarades écrivent eux-mêmes les notes d’étude, c’est pourquoi les documents sont toujours fiables et à jour. Cela garantit que vous arrivez rapidement au coeur du matériel.

Foire aux questions

Qu'est-ce que j'obtiens en achetant ce document ?

Vous obtenez un PDF, disponible immédiatement après votre achat. Le document acheté est accessible à tout moment, n'importe où et indéfiniment via votre profil.

Garantie de remboursement : comment ça marche ?

Notre garantie de satisfaction garantit que vous trouverez toujours un document d'étude qui vous convient. Vous remplissez un formulaire et notre équipe du service client s'occupe du reste.

Auprès de qui est-ce que j'achète ce résumé ?

Stuvia est une place de marché. Alors, vous n'achetez donc pas ce document chez nous, mais auprès du vendeur ib45pointer. Stuvia facilite les paiements au vendeur.

Est-ce que j'aurai un abonnement?

Non, vous n'achetez ce résumé que pour $7.39. Vous n'êtes lié à rien après votre achat.

Peut-on faire confiance à Stuvia ?

4.6 étoiles sur Google & Trustpilot (+1000 avis)

65040 résumés ont été vendus ces 30 derniers jours

Fondée en 2010, la référence pour acheter des résumés depuis déjà 15 ans

Commencez à vendre!
$7.39
  • (0)
Ajouter au panier
Ajouté