Net Exports and International Finance

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• Net Exports and International Finance
• Read Chapter 15 pages 310-326
• I The International Sector An Introduction
• The Case for Trade
• 1) A country has a comparative advantage in
  the production of a good if it can produce it at
  a lower opportunity cost than other countries. If
  countries specialize in production of what they
  do best then global production will be increased
  which can result in more consumption for everyone.

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• 2) Types of restrictions on trade.
• a) A tariff is a tax imposed on imported goods
  or services.
• b) A quota is a ceiling on the quantity of
  specific goods and services that can be imported.
• 3) If one were to argue against free trade one
  would have to argue on normative grounds such as
  valuing,
• a) certain sectors of the economy or
• b) the environment to a greater extent.

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• B) The Rising Importance of International Trade.
• 1) In the U.S. international trade has risen
  from 3.7 of GDP in 1960 to 11.7 of GDP in
  1999.
• 2) Trade has risen as
• a) Costs associated with transportation and
  communication have fallen
• b) Trade barriers have fallen.

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• C) Net Exports and the Economy
• 1) Determinants of Net Exports.
• a) Income higher incomes in the world means
  people will buy more goods and services.
• b) Relative prices a higher price level
  within a country makes one countries goods more
  expensive and thus reduces its exports.

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• c) An increase in the exchange rate means that
  more foreign currency is required to obtain
  domestic currency (i.e. currency is more
  expensive) thus reducing exports.
• d) Trade policies can potentially limit
  exports or imports.
• e) Preferences and technology.
• 2) Net exports affect both the slope and
  position of aggregate demand.
• a) Slope is impacted by the international
  trade effect.
• b) Other factors change the position.

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• II International Finance
• A) International Finance is that field that
  examines the macroeconomic consequences of the
  financial flows associated with international
  trade.
• B) The balance between spending flowing into a
  country and spending flowing out is called the
  balance of payments.
• C) We will look at the balance of payments
  with two simplifications, 1) ignore transfer
  payments, 2) used GNP measurements rather than
  GDP.

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• D) Currency demand comes from two sources.
• 1) Exports.
• 2) Purchases by foreigners of domestic assets.
• E) The supply of currency comes from two
  sources.
• 1) Imports.
• 2) Domestic purchases of foreign assets.

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• F) Currency market equilibrium
• Exports (demand by foreigners of domestic
  assets) Imports (domestic demand for foreign
  assets.)
• G) Accounting for International Payments.
• 1) Exports imports (domestic demand for
  foreign assets)- (demand by foreigners of
  domestic assets). Note there is a typo in
  formula (3) on page 317.

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• 2) The current account is an accounting
  statement that includes all spending flows across
  a nations borders except those that represent
  purchases of assets.
• 3) The balance of current account equals
  spending flowing into an economy from the rest of
  the world on current account less spending
  flowing from the nation to the rest of the world
  on current account. (This equals net exports.)

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• 4) When the balance on current account is
  positive, the country runs a current account
  surplus.
• 5) When the balance on current account is
  negative, the economy is in a current account
  deficit.
• 6) A countrys capital account is an accounting
  statement of spending flows into and out of the
  country during a particular period for purchases
  of assets.

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• 7) If more foreign money flows into a country for
  the purchase of domestic assets than flows out
  for the purchase of foreign assets then there is
  a capital account surplus.
• 8) If less foreign money flows into a country for
  the purchase of domestic assets than flows out
  for the purchase of foreign assets then there is
  a capital account deficit.
• 9) Current account balance -(capital account
  balance)

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• H) Deficits and Surpluses Good or Bad?
• The U.S. has run current account deficits and
  capital account surpluses for the last two
  decades. Is this good or bad?
• Common arguments that it is bad
• 1) Trade deficits mean a lose of jobs.
• This is untrue as can be noting that the last
  twenty years has resulted in increased U.S. job
  creation.
• 2) Foreigners now own parts of the U.S. Nothing
  wrong with this. If anything, it keeps the
  capital in the U.S. supporting our own jobs.

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• III Exchange Rate Systems
• In a free-floating exchange rate system,
  governments and central banks do not participate
  in the market for foreign exchange.
• Government or central bank participation in a
  floating exchange rate system is called a managed
  float.
• 3) A fixed exchange rate system is one in which
  the exchange rate between two currencies is set
  by the government.

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• 4) Types of Fixed exchange rate systems.
• a) In a commodity standard system, countries
  fix the value of their respective currencies
  relative to a certain commodity or group of
  commodities. (e.g. gold)
• b) Currency board arrangements are systems that
  fix the exchange rate to a specified foreign
  currency with a legislative commitment to ensure
  that this rate will hold up.

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• c) Fixed exchange rate through intervention.

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• Some reminders.
• Homework 3 due Wednesday.
• Midterm 3 is Friday. The exam will cover
  chapters 10-15. The format will be the same as
  before with 30 multiple choice questions.
• There is a sample exam as well as powerpoint
  printouts in Eisenhower.
• On Wednesday we will review as much as possible.