real exchange rate

Introduction

  • The discussions are centered around Nobel Prize winning economic theories and the implications for long run economic growth.

  • The course will cover the Solow model and a simplified version of endogenous growth theory based on creative destruction.

  • Emphasis on the students reading relevant press releases and studying important economic theories.

Class Schedule

  • Note: Only one class will be held this week due to travel for a seminar, with a suggestion to book appointments for office hours for next week.

Core Topics of Discussion

Long Run Economic Growth

  • Focus on economic growth models, particularly the Solow model.

Supply and Demand Model

  • Discussion of GDP and national savings identities and their relation to supply and demand models.

  • Key insights into guarantees of net exports matching asset transactions in a market economy.

  • The real exchange rate is crucial to understanding net exports and capital flows in international markets.

Real Exchange Rate Definition

  • Real Exchange Rate: The relative price of domestic goods in terms of foreign goods.

  • Example: Comparing the price of a Big Mac in USD versus yen.

Importance of Real Exchange Rate

  • To determine how many foreign goods must be given up to purchase a unit of domestic goods.

  • If the real exchange rate rises:

    • American goods become more expensive to foreigners.

    • U.S. exports will fall and imports will rise.

  • If the real exchange rate falls:

    • American goods become cheaper internationally.

    • U.S. exports increase and imports decrease.

Conceptual Framework

  • The relationship between exports, imports, and real exchange rate in a small open economy is established through supply and demand diagrams.

  • Observations on how high real exchange rates can lead to reduced net exports and capital outflows.

  • National savings as a function of income minus government spending.

Impact of Fiscal Policies

Expansionary Fiscal Policy

  • Definition: Increasing government deficit through increased government spending (G) or reduced taxes (T).

  • Effects on national savings:

    • S1 to S2 (decrease in national savings).

    • Government borrowing increases, leading to reduced capital available for lending abroad.

  • Outcomes on international markets

    • A shift in the demand curve leading to higher dollar prices on international markets.

Contractionary Fiscal Policy

  • Definition: Reducing government deficit through decreased spending or increased taxation.

  • Results in increased national savings and increased supply of dollars available for lending abroad.

  • Effects on price of the dollar in international markets:

    • Sending less dollar supply leads to depreciation of the dollar, enhancing attractiveness of U.S. exports but making imports more expensive for Americans.

Tariffs and Quotas

Import Quotas

  • Definition: Restrictions on the physical quantities of imports allowed.

  • Example: Reducing imports of toys or cars from certain countries.

Effects of Protectionist Policies

  • Discussion on short-term benefits (increased domestic producer competition) versus long-term implications (higher prices for consumers).

  • Key takeaway: Protectionist policies may not enhance net exports as firms face increased costs due to tariffs leading to potential inflation and inefficiencies in the economy.

Economic Models and Analysis

  • Exploring the equilibrium effects of policies on net exports and the overall economy.

  • Comprehensive understanding of how net capital outflows, net exports, and dollar supply interact in the context of trade policies.

Currency Manipulation

Economic Context of China

  • Discussions on China’s currency strategies to maintain low trading prices.

  • Analysis of potential strategies for the U.S. to address perceived unfair practices without resorting to tariffs.

Nominal Exchange Rates

  • Equations explaining nominal exchange rates derived from the real exchange rate and price levels in domestic and foreign markets.

  • Long-term correlations between inflation differences and the value of currencies relative to the dollar.

Conclusion

  • Continued relevance of the models discussed in capturing the intricate dynamics of trade policy, fiscal policy, and their impacts on economic outcomes.

  • Encouragement for students to actively engage with these concepts, as they reflect real-world economic interactions.

  • Reminder of the complexities of policy effects that students should understand beyond simple accounting measures.