Macroeconomics Chapter 171 World Markets in Goods and Credit C h a p t e r 1 7

Macroeconomics Chapter 17 1

World Markets in Goods and Credit

C h a p t e r 1 7



Assumptions:

the goods are physically identical.

transport costs and barriers to trade small enough to neglect.



law of one price.

Markets work to ensure that the same good sells at the same price for all buyers and sellers in all locations. We also simplify by ignoring inflation, so that the price level, P, is constant over time.



it = if t home nominal interest rate

= foreign nominal interest rate

rt = rft

home real interest rate = foreign real interest rate


The Balance of International Payments

Closed economy:

Yt = Ct+ It+ Gt

real GDP = real domestic expenditure



Open Economy

Exports are the goods and services produced in the home country that are sold to the rest of the world, and

imports are the goods and services produced by the rest of the world that are bought by the home country.

The difference between exports and imports, or net exports, is called the trade balance.



Yt + Impt = Ct+ It+ Gt + Expt

trade balance = Expt - Impt

= Yt − (Ct+ It+ Gt)

trade balance = real GDP − real domestic expenditure



Bft : the net nominal holdings of foreign

assets by the home country at the end of year t.

These assets or debts could be held by the home country’s households or government.

The addition to the home country’s ownership of capital located in the rest of the world is called foreign direct investment.



net real asset income from abroad = rt−1 ·Bf

t−1/P

The total real income of domestic residents in year t is the sum of real GDP, Yt, and the net real asset income from abroad, rt−1 · Bf

t−1/P. This total is called the real gross national product (real GNP).



real GNP= Yt + rt−1 ·B ft−1/ P

real GNP = real GDP+ net real asset income from abroad

(Bft − Bf t−1)/P. is called net foreign

investment



Ct+ It+ Gt + (B ft − B f

t−1)/ P

= Yt+ r t−1·B ft−1/ P

real domestic expenditure+ net foreign investment = real GNP on goods and services



(B ft−Bf

t−1)/P = Yt+ rt−1 ·Bft−1/P − (Ct+ It+ Gt)

net foreign investment = real GNP − real domestic expenditure = real current-account balance



the real current-account balance.

a current-account surplus

a current-account deficit

a balance on current account



(B ft − B f

t−1 )/ P

= Yt− ( Ct+ It+ Gt) + rt−1·Bft−1/P

real current-account balance = trade balance + net real asset income

from abroad


History of the U.S. Current-Account Balance










Chinese Trade Balance

- 10. 00

- 5. 00

0. 005. 00

10. 00

15. 00

20. 00

25. 0030. 00

35. 00

40. 00

1980

1990

1992

1994

1996

1998

2000

2002

2004

2006

GDP出口占比重 GDP进口占比重净出口


Chinese FDI

FDI （亿美元）

0. 00100. 00200. 00300. 00400. 00500. 00600. 00700. 00800. 00

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

FDI


Chinese FDI年份

黄金储备外汇储备

( 万盎司 ) ( 亿美元 )

1978 1280 1.67

1979 1280 8.40

1980 1280 -12.96

1981 1267 27.08

1982 1267 69.86

1983 1267 89.01

1984 1267 82.20

1985 1267 26.44

1986 1267 20.72

1987 1267 29.23

1988 1267 33.72

1989 1267 55.50

1990 1267 110.93

1991 1267 217.12

1992 1267 194.43

1993 1267 211.99

年份黄金储备外汇储备

( 万盎司 ) ( 亿美元 )

1994 1267 516.20

1995 1267 735.97

1996 1267 1050.49

1997 1267 1398.90

1998 1267 1449.59

1999 1267 1546.75

2000 1267 1655.74

2001 1608 2121.65

2002 1929 2864.07

2003 1929 4032.51

2004 1929 6099.32

2005 1929 8188.32

2006 1929 10663.44

2007 1929 15282.49


Determinants of the Current-Account Balance

A small country model:

Production Function: Yt = A· F( K, Lt)

Total Expenditures Yt = Ct+ It+ Gt

the real interest rate on bonds, rt, has to equal the real rate of return on capital rt = MPK − δ



Suppose, to begin, that The real interest rate in the rest of the

world, rf, is constant The domestic real interest rate is also set

at rf

The opening up to the world credit market would not change the real interest rate available to the home country’s households.



The home country would end up with the same real GDP, Yt, consumption, Ct , gross domestic investment, It , and so on.

Therefore, the condition Yt = Ct + It + Gt would continue to hold.

We see, accordingly, that the trade balance would be zero trade balance= Yt - （ Ct + It + Gt ）



The real current-account balance:

(Bft − Bf

t−1)/P = Yt− ( Ct+ It+ Gt) + rt−1·Bf

t−1/P

Since the home country had initially been closed, it must have started with a zero net international investment position, Bf

t−1 = 0.



Effects of an increase in A

(Bft − Bf

t−1)/P = Yt− ( Ct+ It+ Gt) + rt−1·Bf

t−1/P

the net real asset income, r t−1·(Bft−1/P), is given—

for example, at zero if the home country starts with a zero net international investment position, Bf

t−1 /P.

Real government purchases, Gt, are also given.


Determinants of the Current-Account Balance The higher A raises the MPK and thereby

increases gross domestic investment, It.

If the change in A is permanent, Ct will rise by roughly as much as Yt, so that Yt-Ct does not change.

The current-account balance falls overall, i.e., it moves toward deficit because of the increase in It.





current-account balance, saving, and investment (Bf

t − Bft−1)/P =

Yt+ rt−1·Bft−1/P − δ Kt−1 − (Ct+Gt)

− ( It− δ K t−1)

real current-account balance

= real national saving − net domestic investment



Results concerning the opening up of the home country to the world credit market. Suppose that rt > rf. In this case, the

opening up of the home country to the world credit market results in a current-account deficit.

The home country borrows from the rest of the world to pay for higher net domestic investment, It−δKt−1.



Results concerning the opening up of the home country to the world credit market. If rt < rf, the results are the opposite.

The home country has a current-account surplus—it lends to the rest of the world and has lower net domestic investment, It −δKt−1.



Economic Fluctuations A raises net domestic investment, It − δKt−1.

We also have that consumption, Ct, rises, but by less than the increase in real GDP, Yt (because the increase in A is less than fully permanent). Therefore, real national saving increases.

The overall change in the real current-account balance depends on whether It − δKt−1 rises by more or less than real national saving. In general, the overall effect on the real current-account balance is ambiguous.



Economic Fluctuations the equilibrium business-cycle model

predicts that the real current account balance will be countercyclical—low in booms and high in recessions.





Harvest Failures

Consider a harvest failure, which results in a drop in the home country’s real GDP, Yt .

If the harvest failure is expected to be temporary the income effect is weak, and the response of consumption, Ct, is small.

Therefore, Yt − Ct falls sharply—the home country’s real national saving decreases almost one-to-one with the decline in Yt.



The harvest failure may be little impact on the MPK. In this case, there would be little response of net domestic investment, It − δKt−1.

A harvest failure leads to a current-account deficit. The home country borrows from abroad to maintain roughly stable consumption, Ct, and net domestic investment, It − δKt−1.

In this case, a current-account deficit is a symptom of bad economic times.



Government Purchases

wartime government purchases are valid only if we can hold fixed the real interest rate in the rest of the world, rf.

In this case, a current-account deficit is a symptom of bad economic times.



Developing Countries

Suppose that the home country is a developing country with a low capital stock, Kt−1, and a high MPK.

A current-account deficit tends to be a sign of a favorable growth environment, whereas a current-account surplus is a sign of an unfavorable environment.



Case studies: Australia (Scoggins 1990) Poland WWI and WWII Mexico and Brazil


Determinants of the Current-Account Balance The Current-Account Deficit and the Budget

Deficit If we allow for an open economy, the

important issue is still whether a budget deficit affects real national saving.

The real current-account balance is (Bf

t − Bft−1)/P = Yt+ r t−1·Bf

t−1/P − δ Kt−1

− (Ct+Gt)− ( It− δ K t−1)



The Current-Account Deficit and the Budget Deficit In the Ricardian case, a budget deficit

does not change real national saving and real current-account balance would not change.

in the Ricardian case, a budget deficit does not create a current-account deficit.



The Current-Account Deficit and the Budget Deficit If households do not save the full

amount of the tax cut—that is, if a budget deficit reduces real national saving.

Consumption, Ct, rises, and real national saving declines.

A budget deficit leads to a current-account deficit.



The Current-Account Deficit and the Budget Deficit Twin deficits. Economists applied this

label to the U.S. economy in the mid-1980s, when budget deficits were large and the ratio of the current-account deficit to GDP gradually widened.


The Terms of Trade

For heterogeneous goods

The ratio P/Pf is called the terms of trade.

The units for the terms of trade are($ per home good)/( $ per foreign good) = foreign good per home good


The Terms of Trade The terms of trade give the number of units

of foreign goods that can be imported for each unit of home goods exported. If the terms of trade, P/Pf, rise—or

improve—the home country is better off because it gets more foreign goods in exchange for each unit of home goods.

If P/Pf falls—or worsens—the home country is worse off because it gets fewer foreign goods in exchange for each unit of home goods.


The Terms of Trade

In our equilibrium business-cycle model, economic fluctuations result from shocks to the technology level, A.

For a single country, changes in the terms of trade have effects that are similar to changes in A.


The Terms of Trade

The Terms of Trade and the Current-Account Balance current-account balance in nominal

terms is

Bft − Bf

t−1 = P Yt+ rt−1·Bft−1 − P· ( Ct+ It+ Gt)

nominal current-account balance = nomimal GNP − nominal domestic

expenditure


The Terms of Trade

Bft − Bf

t−1 = P Yt+ rt−1·Bft−1 − Pf· ( Ct+ It+ Gt)

(Bft − Bf

t−1)/Pf = (P/Pf)·Yt+ rt−1·(Bft−1/Pf) −

Pf·( Ct+ It+ Gt)

a real value in the sense of being measured in units of foreign goods.


The Terms of Trade

(Bft − Bf

t−1 )/Pf= (P/Pf)·Yt+ rt−1·Bft−1/Pf

−δKt−1 − (Ct+Gt) − (It−δKt−1)

real current-account balance= real national saving − net domestic

investment


The Terms of Trade

The Terms of Trade and the Current-Account Balance An increase in P/Pf raises real GNP, measured

in units of foreign goods, for a given Yt. Households respond to the higher real GNP by

increasing consumption, Ct. The response of Ct is larger the more long-lasting the rise in P/Pf.

As long as the change is less than fully permanent, Ct tends to rise by less than real GNP.

Therefore, real national saving increases The real current-account balance moves

toward surplus.


The Terms of Trade

The Terms of Trade and Investment an increase in the terms of trade, P/Pf,

affects net domestic investment, It−δKt−1.

net real rate of return on capital = (P/Pf)·MPK − δ


The Terms of Trade

The Terms of Trade and Investment The effect of higher terms of trade, P/Pf, on net

domestic investment, It − δKt−1, is analogous to the effect we considered before from an increase in the technology level, A.

When A increased, the rise in the MPK raised the net real rate of return on capital. We noted that the response of It − δK t−1 would be large, typically greater than the increase in real national saving.

The same conclusion applies when the terms of trade, P/Pf, rise. It − δK t−1 will rise by more than real national saving.

Therefore, the real current-account balance moves overall toward deficit.


The Terms of Trade

The Terms of Trade and Investment we predict that an increase in the

terms of trade, P/Pf, that is expected to be permanent moves the current-account balance toward deficit.

The reason is that the expansion of net domestic investment, It − δKt−1, tends to be greater than the rise of real national saving.


The Terms of Trade

The Terms of Trade and Investment we predict that an increase in P/Pf that

is expected to be temporary moves the current-account balance toward surplus.

In this case, the increase of It − δKt−1 tends to be smaller than the rise of real national saving.



The Volume of International Trade

The trade balance is given by trade balance= Yt− ( Ct+ It+ Gt) trade balance= exports− imports trade balance= net exports


The Volume of International Trade

When we studied the impact of the home country’s technology level, A, and other variables on the current-account balance, the effects worked through changes in net exports.

However, the model has nothing to say about the volume of international trade—that is, the absolute levels of exports and imports.

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Macroeconomics Chapter 171 World Markets in Goods and Credit C h a p t e r 1 7