Three categories:

1. Exports of goods and services and income receipts.

2. Imports of goods and services and income payments.

3. Net unilateral transfers (international gifts)

Three options:

1.  Increase the level of saving (CA = S - I).

2. Lower the level of investment (CA = S - I).

3. Reduce the level of government spending (S = Y - C - G).

Three things:

1. The current account balance for that year.

2. Changes in worldwide asset prices.

3. Changes in exchange rates (that are used to convert wealth measured in various currencies into a common currency)

The sum of:

Exports of goods and services and income receipts (Line 1)

Imports of goods and services and income payments (Line 18)

Unilateral current transfers, net (Line 35)

The sum of:

U.S.-owned assets abroad, excluding financial derivatives (Line 40)

Foreign-owned assets in the United States, excluding financial derivatives (Line 55)

Financial derivatives, net (Line 70)

The sum of:

U.S. official reserve assets (Line 41)

Foreign official assets in the United States (Line 56)

*with the sign reversed.

If negative, it implies that the U.S. is running down its official international reserves or borrowing from foreign central banks for that amount.

Occurs when the dollar will purchase more of a foreign currency.

Example: exchange rate changes from 10 euros per dollar to 15 euros per dollar.

The dollar price of foreign goods will fall in dollar terms.

When the dollar will purchase less of a foreign currency.

Example: the exchange rate changes from 10 euros per dollar to 5 euros per dollar.

Depreciation causes the price of foreign goods to rise in dollar prices.

The sum of:

The Euro interest rate (Re)

Expected Rate of Dollar Depreciation

The interest parity condition states that the expected returns on deposits of any two currencies are equal when measured in the same currency.

It implies that potential holders of different currency deposits view them as equally desirable assets.

Relative PPP predicts that inflation differentials are matched by changes in the exchange rate.

Under relative PPP, the Australian dollar/Argentine peso exchange rate would fall by 25%/

That is, the Australian dollar is expected to appreciate against the Argentine peso by 25%.

An increase in U.S. productivity relative to that of the E.U. will cause the real dollar/euro exchange rate to depreciate.  

The real depreciation combined with a fall in the U.S. price level makes the effect on the nominal exchange rate ambiguous.

"An increase in world relative demand for the U.S. output causes a long-run real depreciation of the dollar against the euro."

Do you agree or disagree with this statement?  Explain your answer.

Disagree.

There will be a long-run real appreciation of the dollar.  Absent changes in monetary conditions, there will be long-run nominal appreciation of the dollar as well.

The value of all final goods and services produced by a nation's factors of production in a given time period.

It does not specify that those factors must work within the borders of a country that owns them.

GDP measures the final value of all goods and services that are produced within a country.

GNP = GDP + (payments from foreign countries for factors of production - payments to foreign countries for factors of production)

S = Y - C - G

In the closed economy, S = I.

A closed economy can increase its savings only by accumulating capital.

In the open economy, S = I + CA.

An open economy can save either by building up its capital stock or by acquiring foreign wealth.

Foreign assets held by central banks to cushion against financial instability.

Includes government bonds, currency, gold, etc.

Three things:

1. Interest rate/expected rates of return: A rise in the interest rate causes aggregate money demand to fall.

2. Prices: the prices of goods and services bough in transactions will influence the willingness to hold money to pay those transactions.

* A higher level of average prices means a greater need for liquidity.

3. Real national income (GNP): A higher real national income means more goods and services are being sold in the economy, increasing the need for liquidity.

Md = P x L(R,Y)

P is the price level

Y is real national income

R is the interest rate

In the long run, a change in the supply of money has no effect on the long-run values of real output, interest rates, and the aggregate real money demand, L(R,Y) since all factors are fully employed.

All else equal, an increase in a country's money supply causes a proportional increase in its price level in the long-run.

The equilibrium condition Ms/P = L(R,Y) shows that P is predicted too adjust proportionally when Ms adjusts because L(R,Y) does not change.

PPP implies that:

E$/e = Pus/Pe

The exchange rate between two currencies equals the ration of the countries' price levels.

The monetary approach to the exchange rate uses monetary factors to predict how exchange rates adjust in the long run.

It uses the absolute version of PPP.

It predicts that levels of average prices adjust so that the quantity of real money supply will equal the quantity of real money demand.

A change in the money supply results in a change in the level of average prices.

A change in the growth rate of the money supply results in a change in the growth rate of prices (inflation).

A constant growth rate in the money supply results in a persistent growth rate in prices (ongoing inflation) at the same constant rate, when other factors are constant.

The Fisher effect describes the long-run relationship between nominal interest rates and the inflation rate.

It is expressed as:

R$ - Re = PIus - PIeu

This formula implies that the international interest rate difference equals the international expected inflation difference.

The Fisher effect predicts that a rise in the domestic inflation rate causes an equal rise in the interest rate on deposits of domestic currency in the long run, when other factors remain constant.

The real exchange rate is the rate of exchange for goods and services across countries. The real exchange rate is defined as:

Qus/eu = (E$/e x Peu)/Pus

An increase in relative demand for U.S. goods causes the price of U.S. goods relative to the price of foreign goods to rise.  

This results in a long-run real appreciation of the dollar.

The real appreciation of the dollar makes U.S. exports more expensive and imports into the U.S. less expensive (thereby reducing the relative quantity demanded for U.S. goods to match relative quantity supplied).

A decrease in relative demand for U.S. goods causes a real depreciation of the dollar.

What are the short run and long run effects of a decrease in a country's money supply on:

Price Level

Interest Rate

Nominal Direct Exchange Rate

Real Direct Exchange Rate

Real Money Holdings

Short Run Long Run

Price Level N D

Interest Rate I N

Nominal Direct Exchange Rate D D

Real Direct Exchange Rate D N

Real Money Holdings D N

A permanent shift in the real money demand will alter the long-run equilibrium nominal exchange rate, but not the long-run equilibrium real exchange rate.

A permanent increase in money demand at any nominal interest rate leads to a proportional appreciation of the long-run nominal exchange rate.  Intuitively, the level of prices must be lower in the long run for money market equilibrium.

The reverse holds for a permanent decrease in money demand.  The real exchange rate, however, depends on relative prices and productivity terms which are not affected by changes in monetary factors.