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MONEY AND INFLATION (Continued…):The Classical Dichotomy |
| << MONEY AND INFLATION (Continued…):Costs of expected inflation: |
| OPEN ECONOMY:Three experiments, The nominal exchange rate >> |
MacroeconomicsECO
403
VU
LESSON
14
MONEY AND
INFLATION (Continued...)
TheClassical
Dichotomy
Realvariables
are measured in physical
units: quantitiesand
relative prices,e.g.
�
Quantity
of output produced
�
Realwage:
output earned perhour of
work
�
Realinterest
rate: output earned in the
future
by
lending one unit of
outputtoday
Nominalvariables:
measured
in money units, e.g.
�
Nominalwage:
dollars per hour of
work
�
Nominalinterest
rate: dollarsearned in
future
by
lending one
dollartoday
�
Theprice
level: the amount of dollars
needed
to
buy a representative basket of
goods
�
ClassicalDichotomy:
"Thetheoretical
separation of realand
nominal variables in
theclassical model,
whichimplies
nominalvariables
do not affect realvariables.
"
�
Neutrality
of Money:
Changes
in the money supply do
notaffect real variables. In
the real world, money
is
approximatelyneutral
in the longrun.
TheOpen
Economy
�
Accountingidentities
for the
openeconomy
�
Smallopen
economy model
�
Whatmakes
it "small"
�
Howthe
trade balance andexchange
rate aredetermined
�
Howpolicies
affect tradebalance &
exchangerate
Importsand
Exports as a percentage of
output
40
Percentage
of
GDP 35
30
25
20
15
10
5
0
U.K.
Canada
France Germany
Italy
Japan
U.S.
Pakistan
Imports
Exports
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In
an open economy:
�
Spendingneed
not equaloutput
�
Savingneed
not equalinvestment
Preliminaries
C
=C
d +C
f
I
=Id +If
G
=G
d +G
f
Superscripts:
d
= spending on
domesticgoods
f
= spending on
foreigngoods
EX
= exports = foreign spending on
domestic goods
IM
= imports = C f
+ I f
+ G f
= spending on
foreign goods
NX
= net exports (the
"tradebalance")
=
EX IM
�
If
NX > 0, country has a
tradesurplus equal to
NX
�
If
NX < 0,
countryhas
a trade deficit equal to
NX
GDP
= expenditure on domestically
producedgoods &services
Y
= C
d + I
d + G
d + EX
=
(C
- C
f ) +
(I
- I
f ) +
(G
- G
f ) +
EX
=
C
+ I
+ G
+ EX
- (C
f + I
f + G
f )
=
C
+ I
+ G
+ EX
- IM
=
C
+ I
+ G
+ NX
Thenational
income identity in an open
economy
Y
= C + I + G + NX
Or,
NX
= Y ( C + I + G )
Where,
NX
=> Net Export
Y
=> Output
C
+ I + G => Domestic Spending
NetForeign
Investment and
TradeBalance
�
We
have
48
MacroeconomicsECO
403
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Y
= C + I + G + NX
Re-arranging;
Y
C G = I + NX
�
Recall,
Y C G is national savings
S,
thesum
of private savings (Y T C)
and public savings (T
G).
Hence;
S
= I + NX
or
S
I = NX
�
S
I is the difference
betweendomestic saving and
domesticinvestment, referred to as
Net
ForeignInvestment
�
While
NX is the
TradeBalance
�
So
NetForeign
Investment =
TradeBalance
S
I = NX
Internationalcapital
flows
�
Netcapital
outflows
=S
I
=netoutflow
of "loanablefunds"
=netpurchases
of foreignassets
�Net
capitaloutflows
thecountry's
purchases of foreignassets
minus foreignpurchases of
domesticassets
�
When
S > I, country is a
netlender
�
When
S < I, country is a
netborrower
�
An
open-economy version of
theloanable funds
modelincludes many of
thesame
elements:
Savingand
Investment in a SmallOpen
Economy
Y
= Y
= F
(K
, L
)
productionfunction:
C
= C
( -T
)
Y
consumptionfunction:
I
= I
(r
)
investmentfunction:
exogenouspolicy
variables: G
= G
, T
= T
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NationalSaving:
The Supply of Loanable
Funds
r
S
= Y C(Y T) - G
Nationalsaving
does not
depend
on the interest rate
S,
I
S
Assumptions:capital
flows
�
Domestic
& foreign bonds
areperfect
substitutes
�
Perfectcapital
mobility:
no
restrictions on international trade in
assets
�
Economy
is small:
cannotaffect
the world interestrate,
denoted r*
Investment:Demand
for LoanableFunds
r
Investment
is still a downward-sloping
function
of the interest rate,
butthe
exogenousworld
interest
ratedetermines
thecountry's
level of investment.
r*
I
(r
)
S,
I
I
(r* )
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ClosedEconomy
r
S
rc
I
(r
)
S
I
(
r)c
=
S
...the
interest rate would adjust
to equate investment
andsaving:
A
Small OpenEconomy
r
S
Theexogenous
world interestrate
determinesinvestment
and thedifference
betweensaving
and investment
determinesnet
capital outflows
andnet
NX
exports
r*
rc
I
(r
)
S,
I
I1
51
Table of Contents:
- INTRODUCTION:COURSE DESCRIPTION, TEN PRINCIPLES OF ECONOMICS
- PRINCIPLE OF MACROECONOMICS:People Face Tradeoffs
- IMPORTANCE OF MACROECONOMICS:Interest rates and rental payments
- THE DATA OF MACROECONOMICS:Rules for computing GDP
- THE DATA OF MACROECONOMICS (Continued…):Components of Expenditures
- THE DATA OF MACROECONOMICS (Continued…):How to construct the CPI
- NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
- NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
- NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
- NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
- MONEY AND INFLATION:The Quantity Equation, Inflation and interest rates
- MONEY AND INFLATION (Continued…):Money demand and the nominal interest rate
- MONEY AND INFLATION (Continued…):Costs of expected inflation:
- MONEY AND INFLATION (Continued…):The Classical Dichotomy
- OPEN ECONOMY:Three experiments, The nominal exchange rate
- OPEN ECONOMY (Continued…):The Determinants of the Nominal Exchange Rate
- OPEN ECONOMY (Continued…):A first model of the natural rate
- ISSUES IN UNEMPLOYMENT:Public Policy and Job Search
- ECONOMIC GROWTH:THE SOLOW MODEL, Saving and investment
- ECONOMIC GROWTH (Continued…):The Steady State
- ECONOMIC GROWTH (Continued…):The Golden Rule Capital Stock
- ECONOMIC GROWTH (Continued…):The Golden Rule, Policies to promote growth
- ECONOMIC GROWTH (Continued…):Possible problems with industrial policy
- AGGREGATE DEMAND AND AGGREGATE SUPPLY:When prices are sticky
- AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
- AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
- AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
- AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
- AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
- AGGREGATE DEMAND IN THE OPEN ECONOMY:Lessons about fiscal policy
- AGGREGATE DEMAND IN THE OPEN ECONOMY(Continued…):Fixed exchange rates
- AGGREGATE DEMAND IN THE OPEN ECONOMY (Continued…):Why income might not rise
- AGGREGATE SUPPLY:The sticky-price model
- AGGREGATE SUPPLY (Continued…):Deriving the Phillips Curve from SRAS
- GOVERNMENT DEBT:Permanent Debt, Floating Debt, Unfunded Debts
- GOVERNMENT DEBT (Continued…):Starting with too little capital,
- CONSUMPTION:Secular Stagnation and Simon Kuznets
- CONSUMPTION (Continued…):Consumer Preferences, Constraints on Borrowings
- CONSUMPTION (Continued…):The Life-cycle Consumption Function
- INVESTMENT:The Rental Price of Capital, The Cost of Capital
- INVESTMENT (Continued…):The Determinants of Investment
- INVESTMENT (Continued…):Financing Constraints, Residential Investment
- INVESTMENT (Continued…):Inventories and the Real Interest Rate
- MONEY:Money Supply, Fractional Reserve Banking,
- MONEY (Continued…):Three Instruments of Money Supply, Money Demand