Macroeconomics 2 – Key Vocabulary (Open-Economy Macroeconomics & Growth)

• Aggregate Demand: The total demand for goods and services within an economy at a given overall price level and in a given time period. Aggregate Supply: The total supply of goods and services that firms in an economy plan to sell at a given overall price level in a given time period.

• Persistent external debtor (USA) vs. surplus holders (Germany, China) → sustainability question; amplified by crises/trade wars (e.g., U.S.–China tariffs 2018-19 & new 2025 executive order imposing ≥10 % tariffs; EU 20 %, CN 34 %, IN 26 %, BD 37 %)

• Current-account data:

  • U.S. deficit ↑ (1996-2006 surge)

  • German surplus since early-2000s

  • Cumulated 1980-2017 balances mapped (Lane & Milesi-Ferretti IMF WP 17/115)

• Key guiding questions: Why deficits/surpluses? Sustainability amid crises? Policy coordination?

Tri-Dimensional Openness Paradigm

1. Goods Markets – choice between domestic vs. foreign goods, trade barriers (tariffs/NTBs) ↓ via globalisation.

2. Financial Markets – portfolio choice across borders; capital controls ↓ → daily FX turnover ≈ 7.5\text{ trillion US$} (BIS 2022) ≈ 30× world GDP/day.

3. Factor Markets – FDI & labour mobility; dominated by MNEs; contentious re jobs/competitiveness.

Lecture 1 – Descriptive Trade Facts

• German trade: exports & imports (levels + ratios), persistent surplus.

• Export-ratio heterogeneity 2017 (World Bank): US 12.3 %, JP 16.1 %, DE 47.2 %, NL 86.4 %, CH 65 % …

• Classroom teaser: “Can exports exceed GDP?” (yes, if high re-exports, small open economies, NL>100 %).

Lecture 2 – Nominal & Real Exchange Rates; PPP

Nominal Rate Definitions

• Quantity (direct) quote: E = \text{foreign currency per 1 domestic} – e.g. €1 = 1.09 US$ (Mar 19 2025).

  • Appreciation (€) ⇒ E\uparrow; depreciation ⇒ E\downarrow.

• Price (indirect) quote: reciprocal.

Real Exchange Rate

• Export price in domestic P, import price foreign P^*.

• \epsilon = E \times \frac{P}{P^*} → relative price of domestic goods.

  • Real appreciation: \epsilon\uparrow (domestic dearer).

Purchasing-Power Parity (PPP)

• Absolute PPP (law of one price): \epsilon =1. Rare; impeded by trade costs & sticky prices.

• Relative PPP: \frac{dE}{E}=\pi^* - \pi.

• Big-Mac Index: compute E_{PPP}=\frac{P^*}{P} & gauge under/over-valuation.

Lecture 3 – Balance of Payments & Interest Parity

BoP Structure

• Current Account (CA) = Trade balance + Net income.

  • US 2018: Ex 2 500, Im 3 122 → TB −622; Net income 133 → CA −489 bn US$.

• Financial Account (FA) records net asset flows.

  • US 2018: FA +519; statistical disc. 30 bn US$ (“trade with Mars”).

• Identity (ignoring errors): \text{CA}+\text{FA}=0.

• GDP vs. GNP: \text{GNP}=\text{GDP}+NI (net foreign income).

Uncovered Interest Parity (UIP)

• Derivation (EU investor):
  (1+it)=(1+it^)\,\frac{Et}{E{t+1}^e}
  Approx.: it \approx it^ - \frac{E{t+1}^e - Et}{E_t} .

• Implication: higher expected domestic appreciation (numerator ↓) allows lower i_t.

Lectures 4–5 – Goods Market in an Open Economy (SOLOW-TYPE SHORT-RUN)

Demand for Domestic Goods

Z=C+I+G-\frac{IM}{\epsilon}+X

• Imports IM=IM(Y,\epsilon):\;\partial IM/\partial Y>0,\;\partial IM/\partial \epsilon>0

• Exports X=X(Y^,\epsilon):\;\partial X/\partial Y^>0,\;\partial X/\partial \epsilon<0

Equilibrium (open-economy IS)

Y=C(Y-T)+I(Y,r)+G-\frac{IM(Y,\epsilon)}{\epsilon}+X(Y^*,\epsilon)

• Trade balance point Y_{TB} where NX=0.

Shocks & Policy

• Fiscal expansion (\Delta G>0) → ZZ ↑, Y ↑, NX↓ (twin-deficit).

• Foreign demand ↑ or real depreciation (Marshall-Lerner condition) → ZZ ↑, Y ↑, NX↑.

• Policy mix to cut deficit without output loss: (depreciation + fiscal contraction).

Saving-Investment Identity

CA = S + (T-G) - I; surplus = net lender, deficit = net borrower.

Lectures 6–7 – Mundell–Fleming (IS-LM–UIP) Model

• Goods-market IS (simplified, P/P^=1,\;r=i): Y=C(Y-T)+I(Y,i)+G+NX\Big(Y,Y^,E\Big).

• UIP gives E=\frac{1+i}{1+i^*}E^e; substitute into IS.

• LM: i=i_0 (policy rate).

Flexible Exchange Rates

• Monetary tightening i\uparrow → E\uparrow (appreciation) ⇒ I↓, NX↓ → Y↓.

• Fiscal expansion shifts IS → Y↑; if CB holds i fixed, E unchanged; if CB hikes i (inflation fears) partial crowd-out via appreciation.

Fixed Exchange Rates (Credible Peg E=\bar{E})

• UIP ⇒ i=i^* (monetary policy lost).

• Fiscal policy still effective, but trade-off w/ external balance; CB cannot use i.

• Monetary trilemma: can choose 2 of 3 – (Exchange-rate stability, Capital mobility, Independent MP).

Lectures 8–9 – Exchange-Rate Regimes & Crises

• Bretton Woods (1944-73): dollar-gold peg 35\,/oz; capital-controls; collapse via imbalances.

• Crawling pegs, central-parity bands (EMS → Euro).

• Crisis mechanics: expectation of devaluation ⇒ E{t+1}^et ⇒ i\uparrow.

  • CB options: communicate, intervene (reserve loss), or hike i (recession risk).

• Optimal currency area (Mundell): symmetric shocks, price/wage flexibility, factor mobility.

• Hard pegs / currency boards (e.g., Argentina 1991-2001) – credibility vs. policy strait-jacket; crisis 2001 shows dangers.

Part II – Long-Run Growth

Empirical Facts (Lecture 10)

• Post-1950 rich-country growth ≈ 2 – 3 % p.a.; convergence: poorer OECD members grew faster (Figure 10-2).

• Need PPP adjustment for cross-country welfare measurement (Penn World Tables).

• Debates on GDP ↔ happiness (Easterlin paradox revisions).

Solow Model without Tech Progress (Lecture 11)

• Production per worker y=f(k) with k=K/N; CRS, diminishing returns.

• Capital accumulation:
  \Delta k = s f(k) - \delta k.

• Steady state k^: s f(k^) = \delta k^*; growth of $y$ = 0.

• Higher s ⇒ higher k^,y^ but not higher long-run growth.

• Golden Rule: maximise $c=f(k)-\delta k$ ⇒ f'(kG)=\delta ⇒ saving sG.

Solow with Technological Progress (Lecture 12)

• Effective labour A N grows at gA+gN.

• Redefine variables per effective worker \tilde{k}=K/(AN), \tilde{y}=Y/(AN).

• Accumulation: \Delta \tilde{k} = s f(\tilde{k}) - (\delta+gA+gN)\tilde{k}.

• Steady state: \tilde{k}^* constant → balanced-growth: gY = gK = gA + gN.

• Permanent growth driven solely by g_A (tech progress).

• ↑ saving rate ⇒ transitory higher growth, higher long-run level of \tilde{y}.

Sources & Determinants of g_A

• R&D intensity (2-3 % GDP in rich economies).

• Fertility of research (basic ↔ applied, human capital, FDI, global diffusion).

• Appropriability: patent laws, IP protection vs. open knowledge; institutions matter (high correlation between property-rights index & GDP/capita).

Growth Accounting Evidence

• For 1985-2018, TFP contributes bulk of rich-country per-hour growth (≈ 1-1.4 pp of 1.5-2 %).

• China 1996-2008: high TFP (5.6 %) + capital deepening (8.6 %) → super-growth; slowdown post-2008 as TFP ↓ to 2.3 %.

Lecture 13 – Challenges of Growth

Technological Progress & Labour Markets

• Historical fears (Keynes 1930 “technological unemployment”, Leontief 1952).

• Robotisation study (Acemoglu & Restrepo 2020): +1 robot ⇒ −6 jobs, wage pressure in exposed U.S. commuting zones.

• Mixed evidence: productivity effect vs. displacement; net outcome ambiguous across periods.

Inequality Dynamics

• Skill-biased tech change → rising college wage premium; routine-task offshoring amplifies.

• Top-1 % income share ↑ markedly in US since 1980.

• Cross-OECD variation: policy-driven redistribution (market vs. disposable Gini).

Globalisation, Offshoring & Value-Chains

• Two effects of Northern automation on Southern exporters (Baur et al. 2023):

  • Replacement (same industry) negative.

  • Productivity spillover (other industries) positive.

• Policy implication: position in GVCs matters.

Policy, Ethics, and Open Questions

• Trade-offs under openness: fiscal policy spill-overs → need for coordination (e.g., G20 2009 stimulus).

• Exchange-rate regime choice: flexible favoured unless OCA criteria met or credibility crisis (hyper-inflation) warrants hard peg.

• Growth vs. well-being: GDP gains may coexist with distributional tensions; policy must balance innovation incentives with social safety nets.

• Long-run sustainability: debt-financed external deficits, environmental constraints, climate-policy-induced structural change remain central.

Key Equations (quick reference)

1. Real exchange rate: \epsilon = E \frac{P}{P^*}

2. Relative PPP: \frac{\dot{E}}{E}=\pi^*-\pi

3. Current-account identity: CA = S + (T-G) - I

4. UIP exact: (1+i)=(1+i^)\frac{E}{E^e{+1}}; approx.: i \approx i^ - \frac{E^e{+1}-E}{E}

5. Open-economy IS: Y=C(Y-T)+I(Y,i)+G+NX\big(Y,Y^*,E\big)

6. Capital dynamics (no tech): \Delta k = s f(k) - \delta k

7. Golden Rule: f'(k_G)=\delta

8. Capital dynamics (with tech): \Delta \tilde{k} = s f(\tilde{k}) - (\delta+gA+gN)\tilde{k}

End of consolidated study notes – replace original 284-slide deck for exam prep.