Open Economy

Question 1

Three dimensions of openness

Answer 1

Goods, Financial and Factor Markets

Question 2

Trade balance equation

Answer 2

Exports - Imports

Question 3

Consumers choice in a Closed Economy

Answer 3

Decisions over how much to consume or save

Question 4

Consumer choice in an Open Economy

Answer 4

Decisions over whether to buy domestic or foreign goods

Question 5

Real exchange rate (e)

Answer 5

not observed, only the nominal exchange rate is observed

Question 6

Nominal exchange rate

Answer 6

Price of foreign currency in terms of the domestic currency

Question 7

Appreciation of currency

Answer 7

Increase in price relative to foreign

Question 8

Depreciation of currency

Answer 8

Decrease in the price relative to foreign

Question 9

Price index (GDP deflator)

Answer 9

e=EP/P*

Question 10

Foreign exchange

Answer 10

Buying and selling of foreign currency

Question 11

Financial diversification

Answer 11

Holding both domestic and foreign assets (allows to speculate on foreign interest rates)

Question 12

Current Account

Answer 12

Transactions to and from the RoW

Question 13

Decision to invest abroad

Answer 13

Dependant on interest rate differences and expectations about nominal exchange rate

Question 14

Interest Parity Condition (IPC)

Answer 14

Domestic interest rate = foreign interest rate minus (plus) the expected appreciation (depreciation) rate of the domestic currency

Question 15

Demand for domestic goods in an open economy

Answer 15

Z=C+I+G-(IM/e)+X

Question 16

The real exchange rate affects…

Answer 16

…the composition of consumption and investment, but not overall level of these aggregates (still dependent on disposable income); % of foreign goods compared to % domestic goods

Question 17

Determinants of imports

Answer 17

IM (Y(+), e(+)) (SPICED)

Question 18

Determinants of exports

Answer 18

X (Y*(+), e(-)) (SPICED)

Question 19

The goods market is in equilibrium when…

Answer 19

…domestic output equals demand for domestic goods (both foreign and domestic): Y=Z

Question 20

An increase in domestic demand leads to…

Answer 20

1) increase in output, 2) fall in net exports (trade deficit)

Question 21

Differences between an open and closed economy

Answer 21

1) effect on the trade balance (-ve relationship between output and net exports), 2) multiplier is smaller in an open economy (fiscal policy less effective)

Question 22

Multiplier in an open economy

Answer 22

1/(1 - c1 + m1)

Question 23

Output in an open economy

Answer 23

Y = (1/ 1-c1+m1)(c0 + c1T + I + G + x1Y*)

Question 24

An increase in foreign demand leads to…

Answer 24

…1)increase in output, 2)increase in net exports (imports increase but not enough to offset exports) (shift in NX line outwards)

Question 25

Marshall-Lerner condition

Answer 25

real depreciation leads to an increase in net exports

Question 26

Expansionary fiscal policy leads to...

Answer 26

...upward shift in domestic demand and an increase in imports (trade deficit)

Question 27

Mundell-Fleming model

Answer 27

Interest parity relation

Question 28

MF assumptions

Answer 28

1) Home and foreign prices are fixed 2) Demand determines output 3) Perfect capital mobility and home and foreign bonds are perfect subs

Question 29

Current exchange rate depends on....

Answer 29

...Current and expected domestic and foreign interest rates for each year the expected exchange rate at the end of the period Et=((1+it)/(1+i*t))Eet+1

Question 30

Under a fixed exchange rate...

Answer 30

increases in domestic demand for money must be matched by increases in supply of money Central bank loses monetary policy as a policy instrument, fiscal policy is more effective

Question 31

In the short run, prices are...

Answer 31

... fixed

Question 32

In the medium run, prices are...

Answer 32

... allowed to change (AD/AS model)

Question 33

The expected price level affects....

Answer 33

...nominal wages which affect price levels

Question 34

Equilibrium will always be restored in the....

Answer 34

...Medium run