Macroeconomics I
Prof. Isaac Baley and Davide Debortoli
The Open Economy
Stimulus Packages and Exchange Rate Policies
The Demand for Goods in an Open Economy
Demand DD
(D or Z)
Domestic Demand:
DD : C (Y-T) + I (Y ,r) + G
The Demand for Goods in an Open Economy
Demand DD
(D or Z) ZZ
Domestic Demand:
DD : C (Y-T) + I (Y ,r) + G
Demand for Domestic Goods
ZZ : DD + NX(Y,Y*, ε )
YTB Y
NX
Surplus
YTB Deficit
Output with Balanced Y
Trade (NX=0)
The Demand for Goods in an Open Economy
Demand DD
(D or Z) ZZ
Domestic Demand:
DD : C (Y-T) + I (Y ,r) + G
Demand for Domestic Goods
ZZ : DD + NX(Y,Y*, ε )
YTB Y
NX
NOTE:
• when Y↑ NX↓(because IM↑)
Surplus
• when Y*↑ NX↑(because X↑)
YTB Deficit
• when ε↑ NX↓(Marshall-Lerner) Output with Balanced Y
Trade (NX=0)
Fiscal Policies in the Open Economy
1) Fiscal expansion in home country (higher expenditure or lower taxes)
- Increase in domestic Output (Y↑) … but SMALLER than for a closed economy
- Trade balance DETERIORATES (NX↓)
Fiscal Policies in the Open Economy
1) Fiscal expansion in home country (higher expenditure or lower taxes)
- Increase in domestic Output (Y↑)
- Trade balance DETERIORATES (NX↓)
2) Fiscal expansion in foreign country increase in foreign output (Y*↑)
- Increase in domestic Output (Y↑)
- Trade balance IMPROVES (NX↑)
Fiscal Policies in the Open Economy
1) Fiscal expansion in home country (higher expenditure or lower taxes)
- Increase in domestic Output (Y↑)
- Trade balance DETERIORATES (NX↓)
2) Fiscal expansion in foreign country increase in foreign output (Y*↑)
- Increase in domestic Output (Y↑)
- Trade balance IMPROVES (NX↑)
HOME country would prefer FOREIGNERS to stimulate demand
and viceversa, i.e. a “free-rider” problem
ROLE for Coordination of Demand Policies (G8, G20, etc)!
COORDINATION PROBLEMS LEED TO LONGER CRISIS AND LARGE IMBALANCES
http://www.economist.com/blogs/charlemagne/2011/02/saving_euro
Fiscal Policies in Response of COVID-19
Two key points:
1) Quicker than in response to Financial Crisis of 08-09 (especially in Europe)
2) Unprecedented intervention by individual countries/regions
In the EU: €2.02 trillion package over 2021-2027 (13% of 2019 GDP)
In the US: $1,9 trillion American Rescue Plan (9% of GDP)
Overall: $7.6 trillion in the G-20 countries (11% of GDP)
Practice question 1 (M3-M4)
Suppose that the open economy is in equilibrium in the market for goods at output Y0 = ,
but the trade balance is in deficit (NX0<0).
Suppose also that the government of this country has two policy objectives:
1. Keep output equal to a target level (Y= )
2. Keep Trade Balance equal to zero (NX=0).
The appropriate combination of policies to reach simultaneously these two objectives are a
fiscal __________________ and a real exchange __________________ .
Suppose that the open economy is in equilibrium in the market for goods at output Y0 = ,
but the trade balance is in deficit (NX0<0).
Suppose also that the government of this country has two policy objectives:
1. Keep output equal to a target level (Y= )
2. Keep Trade Balance equal to zero (NX=0).
The appropriate combination of policies to reach simultaneously these two objectives are a
fiscal and a real exchange
Demand DD
DD’
ZZ=ZZ’
Note: any policy combination
should leave ZZ unchanged.
NX needs to shift to the right.
G↓: DD shifts down, ZZ shifts down
ANSWER: ε↓: NX shifts up, ZZ shifts up
- decreasing domestic demand
(G↓) AND 45⁰
- depreciation (ε↓).
Y0= Ŷ Y
NX
YTB Y0= Ŷ
Y
NX’
NX
Practice question 2 (M3-M4)
Suppose a country is initially in a
situation with balanced trade (NX=0).
Suddenly, the government decides
to increase import tariffs, so that
other things equal, the price of
imported goods increases.
In the following graph, indicate the
level of output in the initial (Y0) and
final point (Y1), as well as the initial
and final position of the NX curves
(NX0 and NX1)
Suppose a country is initially in a
situation with balanced trade (NX=0).
Suddenly, the government decides
to increase import tariffs, so that
other things equal, the price of
imported goods increases.
In the following graph, indicate the
level of output in the initial (Y0) and
final point (Y1), as well as the initial
and final position of the NX curves
(NX0 and NX1)
Suppose a country is initially in a
situation with balanced trade (NX=0).
Suddenly, the government decides
to increase import tariffs, so that
other things equal, the price of
imported goods increases.
In the following graph, indicate the
level of output in the initial (Y0) and
final point (Y1), as well as the initial
and final position of the NX curves
(NX0 and NX1)
Note: We assume perfect substitution between domestic
and foreign goods, both in consumption and production.
Current Events
17
EU vs Russia
Following Ukraine’s invasion,
EU raises tariffs on imports from Russia
EU vs Russia
What is the expected economy impact
from EU’s import tariffs?
1) Let’s consider what would happen in Russia (foreign economy)
Russian exports decrease, NX fall, Y* falls
2) Now let’s consider what would happen in EU (domestic economy)
- Direct effect: Imports from Russia decrease, NX improves, Y increases
-Indirect effect: Fall in Y*, EU exports decrease, NX deteriorates, Y falls
- Aggregate effects:
‣ Tariffs may have no (or even negative) effect on NX and Y in Europe
‣ However, both exports and imports would decrease (less trade)
- Distributional effects:
(i) consumers, (ii) exporting and (iii) non-exporting firms
U.S. vs China
U.S. raises import tariffs
China depreciates its currency
A currency depreciation as a “retaliation” strategy
1) Increase in import tariffs (see previous example)
• direct and indirect effects
2) Appreciation of the U.S. dollar
• U.S. exports decrease, Chinese exports increase
The outcome of such a “war” is ambiguous!
Also may have redistribution effects
