Macroeconomics of the Open Economy

Lecture 1: Open-Economy Macroeconomics

and International Finance: introduction

Dr Gabriela Grotkowska

• Lecture (30 h) + tutorial (30 h)

• Examination: multiple choice + open questions (graphs, definitions, problems to solve)

• Final grade: 20% (tutorial) + 80% (final exam)

• Website: www.wne.uw.edu.pl/~ggrotkowska

• Mail address: ggrotkowska@wne.uw.edu.pl

• Office hours: TBA

Mac

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• What is it all about?

• Two legs:– Open-economy Macroeconomics

– International finance

• Finance and macro: does a fact that we consider an open economy change anything?– Specifics of an open economy

– New problems and challanges (external equilibrium)

• Four dimensions:– Theory

– Evidence

– Policy

– Institutions

• Two key notions:

– Exchange rate

– Balance of payments

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• Introduction: technical information, course content overview, basic notions

• Balance of payments: accountancy of international flow of good and assets; structure of the balance of payments: a double entry rule; basic identity of balance of payments; balance of payments equilibrium; savings, investments and current account: twin deficits hypothesis

• Classic approach to balance of payments structure: intertemporal approach; Savings and investments in the classic model (role of economic policy); intertemporal optimalisation (pure exchange and production case), intertemporal comparative advantage

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• Exchange rate and exchange market: participants and transitions, basic instruments and operations, equilibrium setting, two- and three currency arbitrage

• Determinants of the exchange rate:

– In the short run: interest rate parity (market efficiency, links with money market)

– In the long run: purchasing power parity

– Balassa-Samuelson effect

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• Long-run equilibrium: monetary model of balance of payments and exchange rate

• Money supply and balance of payments

• Overshooting of the exchange rate: role of expectations and short-run market rigidity

• Elasticity approach to exchange market equilibrium (Marshal – Lerner condition for devaluation efficiency), J-curve, exchange market stability

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• Multiplier approach to the balance of payments equilibrium; internal and external equilibrium: Swan diagram

• Mundel-Flemming model of short-run macroeconomic equilibrium

• Macroeconomic policy in an open economy (floating exchange rate versus fixed exchange rate regime)

• Currency crises – different approaches

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• International monetary system

• Currency union: optimal currency area, economic aspects of convergence criteria, nominal and real convergence

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• G. Gandolfo, International Finance and Open-Economy Macroeconomics, Springer 2002

• C.P. Hallwood, R. MacDonald, International Money and Finance, Blackwell 2000

• P. Krugman and M. Obstfeld, Intenrational economics, Theory and Practive, Addison-Wesley 2005

• R. Caves, J. Frankel, R. Jones, World trade and payments : an introduction, Harper Collins 1996.

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• Autarchic Economy

• Open economy:– exchange of goods and services

– capital flows (international investment and lending activities) intertemporal trade

– international migrations financial aspects – flows of income and remittances

– economic integration (FTA, customs union, single market, monetary union, economic union)

– macroeconomic links

• The concept of the global economy

Au

tark

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0

2000

4000

6000

8000

10000

12000

14000

16000

GDP of biggest economies in 2008, bln USD, Nominal exchange rate

Source: World Bank 2010

Big

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Three biggest economies produce about 40% of the

world GDP.

Share of Poland in the world GDP is equal to 0.9%.

China and India is populated with 37.3% of the world population, but produce 9.3 % of the world GDP.

Ten years ago, it was only 3.6%!

USA is inhabilted with 4.6% of the world population, but produces 25$ of the world GDP.

Three biggest high income economies (USA, Japan and Germany) produce almost 40% of the world GDP, although are inhabilted by only 6% of the world population.

Big

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After corrections for PP, three biggest economies are: USA, China and India.

Share of Poland in the world PGD rises up to 1% In both cases we are 19th in the world.

0 2000 4000 6000 8000 10000 12000 14000 16000

Turkey

Canada

Korea, Rep. of

Spain

Mexico

Italy

Brazil

France

United Kingdom

Russian Federation

Germany

India

Japan

China

United States

GDP of the biggest economies in 2008, bln USD, according to nominal wxchange rate corrected for

PPP, źródło: World Bank 2010

By PPP

By nominal exchange rate

• Multinational corporations (MNC): particular actors in the world economy

• Their importance for trade and capital flows

• List of top 500 enterprises

• http://money.cnn.com/magazines/fortune/global500/2008/full_list/

• For comparison GDP:

– Ireland: 200 bln $

– Poland 300 bln $

– Belgium 400 bln $

– Russia 600 bln $

• In which economic sectors MNC operate? Where do they come from?

Mu

ltin

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Trad

e a

nd

inve

stm

en

ts

gro

w f

aste

r th

an G

DP

14

Trade, GDP and FDI

1948 19971973

Growth of the world exports

Changes in world flows of FDI

Growth of world production (GDP)

10 %

8

6

4

2

0

+ 6%

+ 1.9%

x 16

Ch

arac

teri

scs

of

FOR

EX

15

Ch

arac

teri

scs

of

FOR

EX

16

Ch

arac

teri

scs

of

FOR

EX

17

37%

18%6%5%

5%

5%

4%

3%

2% 2% 13%

Struktura geograficzna światowego rynku walutowego (BIS, 2010)

United Kingdom United States Japan Singapore

Switzerland Hong Kong SAR Australia France

Ch

ina

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orl

dtr

ade

sy

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• China: new player in the world economy

Ris

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GLOBAL CURRENT ACCOUNT BALANCES

(per cent of World Output)

-3

-2

-1

0

1

2

3

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

US Oil Exporters Germany and Japan Other Deficit Countries

China and East Asia Rest of World Discrepancy

Ch

ina

trad

e s

urp

lus

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CURRENT ACCOUNTS OF WORD'S THREE LARGEST SURPLUS

COUNTRIES ($bn)

-$100.00

$0.00

$100.00

$200.00

$300.00

$400.00

$500.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

China Germany Japan

Source: IMF WEO