Chapters 17: Exchange rate and balance of payments

Transcription

1 Chaptrs 17: Exchang rat and balanc of paymnts Ky ida: w dvlop an opn-conomy vrsion of IS-LM modl which shows how GDP, intrst rat and xchang rat (th thr ndognous variabls) ar dtrmind in short run with sticky pric. Lt E dnot th nominal xchang rat, quotd as forign currncy pr US dollar. You can find th nominal rat in nwspaprs such as WSJ. Th xchang rat allows popl to compar prics across countris. For instanc, suppos an ipad is sold in US for 100 dollar, and th sam ipad is sold in China for 800 Chins yuan. Th currnt nominal xchang rat is 6 yuan pr dollar (on dollar can trad for 6 yuan on th forign xchang markt). In this cas, th yuan pric of th Chins ipad is ; th yuan pric of th US ipad is. Popl can do arbitrag by buying ipad in (China US) sinc its pric is low and sll it in (China US) whr th pric is high. This transaction will incras th ipad pric in (China US) and lowr th pric in (China US). Th arbitrag will continu until th prics ar qual in two countris, or EP = P (1) whr P is th domstic pric (US pric), and P is th forign pric (China pric). Equation (1) is calld purchasing powr parity (PPP) or Law of On Pric (LOOP). In rality, du to factors such as transaction cost and customs duty, arbitrag may not happn vn though EP P. In othr words, PPP may not hold in practic. Howvr, th ratio of rlativ prics ε = EP P (2) calld ral xchang rat, is always maningful. Whn ε riss (ral apprciation of dollar), Amrican goods bcom (mor lss) xpnsiv rlativ to Chins goods, bcaus E riss (nominal apprciation), P riss (US inflation) or P falls (China dflation). Q1: find ε and E whn th PPP holds. Q2: how dos th nominal apprciation of yuan affct US import from China? Q3: Us quation (1) to show how th quantitativ asing in US affcts its xchang rat? 1

2 Exchang rat also allows popl to compar th rturns of financial assts such as dmand dposits in two countris. Suppos th domstic intrst rat is i, th forign intrst rat is i. An invstor has two options if thr is no capital control: (Option A: opn a domstic saving account) on dollar (principal) will bcom aftr on yar (Option B): Currntly on dollar can b convrtd to forign currncy. Aftr putting that mony in a forign saving account, it bcoms forign currncy aftr on yar, which can b convrtd back to dollar. Th arbitrag will continu until th rturns of options A and B ar qual, i.., 1 + i t = (1 + i t ) E t (3) E t+1 whr E t is th currnt xchang rat, and E t+1 is th xpctd xchang rat nxt yar. Equation (3) is calld uncovrd intrst parity (UIP). By using th math fact log (1 + x) x whn x is clos to zro, w can show log(1 + i t ) = log(1 + i t ) (log(e t+1 ) log(e t )) or i t i t E t+1 E t (4) E t Equation (4) maks it clar that on must tak xchang rat into account whn making intrnational financial dcision. Q4: how dos an xpansion montary policy in US affct i t, E t and E t+1? In rality, invstor may car about risk in addition to th rturn. Invstors may ask for highr forign rturn in ordr to compnsat th prcivd risk (ctris paribus, invstors prfr domstic asst). Thus th risk-prmium-augmntd UIP is whr θ is th risk prmium. i t i t E t+1 E t θ (5) E t Q5: how dos th potntial capital control or political turmoil in Argntina affct θ and E t holding vrything ls qual? Q6: To avoid furthr dprciation of Rubl, what should Russian cntral bank do about th intrst rat i t? To summariz, th nominal xchang rat can b drivn by factors in financial markt (quation (4)) or factors in goods markt (quation (1)). Thy ar calld asst approach and montary approach of dtrmining th xchang rat. 2

3 Th balanc of paymnts (BOP) rcords a country s transaction with th rst of world. Th currnt account (CA) is qual to th sum of th trad balanc (xport of domstic goods minus import of forign goods), nt factor incom, and nt unilatral transfr. Th financial account (FA) is qual to capital inflow (xport of domstic asst) minus capital outflow (import of forign asst). Thr xampls of doubl-ntry bookkping of th balanc of paymnts: Exampl 1: US imports $1000 worth toys from China, and snds th Chins sllr a chck drawn upon a US bank. Exampl 2: Japan buys $1000 US Trasury bond, and snds th US trasury a chck drawn upon a Japans bank. Exampl 3: China bartrs furnitur worth $1 million for oil with Russia Bcaus of th doubl-ntry bookkping, w hav th following accounting idntity Currnt account + Financial account (usd to b calld capital account) = 0 (6) Th accounting idntity (6) implis that a country that runs dficit in currnt account must run (dficit surplus) in financial account, which mans nt capital (inflow outflow), or nt (borrowing lnding). Q7: How dos th rising US trad dficit with China affct its dbt? Q8: Can a country run dficit in currnt account forvr? To summariz, th currnt account and financial account ar mirror imags of ach othr. A currnt account dficit is financd by nt capital flows from th rst of th world, thus by a financial account surplus. 3

4 Chaptrs 18: Goods markt and trad balanc Th dmand for domstic goods, Z, is givn by Z = C + I + G IM ε + X (7) W subtract th import IM bcaus som of consumption, invstmnt and govrnmnt xpnditur go to forign goods. W add th xport X bcaus thr is dmand for domstic goods in forign countris. W divid import by th ral xchang rat ε to mak it comparabl to xport (1/ε is th pric of forign goods in trms of domstic goods). W assum that import riss whn domstic incom riss, or whn dollar apprciats in ral trms (forign goods gt chapr): IM = IM(Y, ε), ( IM Y > 0, IM ε > 0) (8) Export ris whn forign incom riss, or whn dollar dprciats in ral trms: X = X(Y, ε), ( X X > 0, < 0) (9) Y ε Not that falling ε (ral dprciation of domstic currncy) rducs both th dnominator and numrator of IM, so in ε thory th ffct on nt xport is ambiguous. Howvr, undr th Marshall-Lrnr condition (MLC), ral dprciation lads to an incras in nt xport, i.., dnx dε < 0 Marshall Lrnr condition (10) W assum MLC holds thraftr. Thr ar thr stps to draw th opn-conomy Kynsian Cross. W put th output of domstic goods (Y) on horizontal axis, and Dmand on th vrtical axis. Stp I: draw th domstic dmand DD curv that rprsnts (C + I + G), which is (upward downward) sloping, and th slop is (gratr lss) than unity. Stp II: subtract th import, which (riss falls stays constant) whn Y riss. In th graph w gt AA lin (C + I + G IM ε ) Stp III: add th xport, which (riss falls stays constant) whn Y riss. Now w gt ZZ lin (C + I + G IM ε + X) It is clar that th distanc btwn th ZZ and DD lin is nt xport or trad balanc. Whn Y is small, IM is (small big), and trad balanc is (positiv ngativ); whn Y is big, IM is (small big), and trad balanc is (positiv ngativ). Draw Figur 18-1 hr: 4

5 Q1: why is ZZ lin flattr than DD lin Q2: what is th ffct of fiscal xpansion (rising govrnmnt xpnditur) on th trad balanc? Figur 18-3 Chaptr 19: Output, Intrst Rat and Exchang Rat (Mundll-Flming Modl) W assum pric is sticky in short run. In that cas w can ignor th diffrnc btwn ral and nominal xchang rat, and ral and nominal intrst rats. Th goods markt is charactrizd by th IS quation Y = C(Y T) + I(Y, i) + G + NX(Y, Y, E) (11) Th domstic mony markt is charactrizd by th LM quation M P = YL(i) (12) Finally, th intrst parity holds in th forign xchang markt whn thr is no capital control: whr w assum a givn xpctd futur xchang rat E. E = 1 + i 1 + i E (13) Q1: plas draw Figur 19-1, which rlats E to i for givn i and E. What will happn whn i riss? Q2: plas show th ffct of a contractionary montary policy (Figur 19-3). Som countris us fixd xchang rat. That mans E = E in (13), and it follows that i = i (14) So thos countris (without capital controls) ffctivly giv up montary policy as a policy tool. Q3: how to xplain that China has bn holding mor and mor US govrnmnt dbt? 5