International Economics
Week 1
GNP is produced by factors of production. GDP is within country borders. GDP = GNP – produced
abroad + produced at home with other country’s factors.
GNP = C + I + G + CA
Products not purchased are counted as inventory investments.
Y + IM = C + I + G + EX
CA = EX – IM. Surplus or deficit. When there is a surplus a country increases its net foreign assets.
Not consumed is being saved. S = Y – C – G = (Y – C – T) + (T – G) = Sp + Sg
CA = Y – (C+ I + G) = S – I. So Current Account is national saving minus investment change in
net foreign assets.
Investment can be financed by saving or by foreign funds.
CA = Sp + Sg – I = (Sp – I) + (T-G). Twin deficit when CA and government budget are negative. A
deficit in the budget corresponds to a current account deficit if the private sector does not increase
savings. This all is an ex post identity, so it does not necessarily work to reduce imports.
Balance of Payments can contain errors. Each transaction enters the accounts twice. Once as a credit
and once as a debit.
CA + FA + KA = 0
Capital account is special transfers of assets.
For credit and debit you look at the money flow.
FA = reserves + private + ERR
Intervention of the CB leads to depletion of reserves. Net central bank financial flows is official
settlements balance or Balance of Payments in narrow sense. BoP = CA + FA non-reserve + stat.
discr.
CA + FA non-reserve + stat discr. + FA reserve = 0
BoP = - FA reserve
BoP deficit is thus solved by selling reserves. This is the case when FA non-reserve (+ stat. discr.)
does not offset the CA deficit.
So with BoP deficit the reserves are depleted. Under floating exchange rates the BoP should be zero.
, Week 2
E = home currency / foreign currency. Depreciation of home means that e goes up. The relative value
of the currency goes down. Appreciation is the other way around.
Devaluation is an official lowering of the value. Revaluation is official raising of value.
Spot rate exchange rate is in the present. Forward rates is exchange rate of a future exchange. The rate
is negotiated.
By real depreciation the domestic goods are relatively cheap. Competitiveness increases so exports
rise and imports go down. The Current Account improves. Initially the CA can worsen when export
and import does not adjust immediately (J-curve).
The Law of One Price says Pi = e Pi*. The same good in different countries should be the same price
when there are no transportation costs or barriers. There are also non-tradable goods.
Purchasing power parity says e = P/P*. This is about general price levels. In practice it is not realistic.
It says that there is depreciation when prices rise. The money becomes worth less.
Relative PPP is about growth rates. Π = dee + π*
(Eus – Eusoud)/Eusoud = πus – πeu
It says that when prices rise more than in foreign, the currency must depreciate.
Relative PPP is more consistent. Nog een keer kijken in het boek
Even though home interest rates are higher, sometimes it is better to make a foreign deposit. This
depends on the expected exchange rate (UIP) or the forward exchange rate (CIP).
Uncovered assumes there is risk-free security, same liquidity and no transaction costs.
In home you get a certain return. In foreign exchange first, then you get an interest rate and then you
exchange back. So it depends on the expected exchange rate.
Eventually there will be an equilibrium. 1 + i = Ee /E (1+i*)
When the left part is higher there will be a capital inflow. Demand for home currency increases so that
E appreciates.
i – i* = (ee – e)/e. This is the expected rate of depreciation.
Covered interest parity is there to cover the exchange rate risk. You get the forward rate f.
i – i* = (f-e)/e
Monetary approach
This is a long run model. Prices are flexible.
Real money demand = liquidity preference
Md/P= L(R,Y)
Ms = Md
P = eP*
Week 1
GNP is produced by factors of production. GDP is within country borders. GDP = GNP – produced
abroad + produced at home with other country’s factors.
GNP = C + I + G + CA
Products not purchased are counted as inventory investments.
Y + IM = C + I + G + EX
CA = EX – IM. Surplus or deficit. When there is a surplus a country increases its net foreign assets.
Not consumed is being saved. S = Y – C – G = (Y – C – T) + (T – G) = Sp + Sg
CA = Y – (C+ I + G) = S – I. So Current Account is national saving minus investment change in
net foreign assets.
Investment can be financed by saving or by foreign funds.
CA = Sp + Sg – I = (Sp – I) + (T-G). Twin deficit when CA and government budget are negative. A
deficit in the budget corresponds to a current account deficit if the private sector does not increase
savings. This all is an ex post identity, so it does not necessarily work to reduce imports.
Balance of Payments can contain errors. Each transaction enters the accounts twice. Once as a credit
and once as a debit.
CA + FA + KA = 0
Capital account is special transfers of assets.
For credit and debit you look at the money flow.
FA = reserves + private + ERR
Intervention of the CB leads to depletion of reserves. Net central bank financial flows is official
settlements balance or Balance of Payments in narrow sense. BoP = CA + FA non-reserve + stat.
discr.
CA + FA non-reserve + stat discr. + FA reserve = 0
BoP = - FA reserve
BoP deficit is thus solved by selling reserves. This is the case when FA non-reserve (+ stat. discr.)
does not offset the CA deficit.
So with BoP deficit the reserves are depleted. Under floating exchange rates the BoP should be zero.
, Week 2
E = home currency / foreign currency. Depreciation of home means that e goes up. The relative value
of the currency goes down. Appreciation is the other way around.
Devaluation is an official lowering of the value. Revaluation is official raising of value.
Spot rate exchange rate is in the present. Forward rates is exchange rate of a future exchange. The rate
is negotiated.
By real depreciation the domestic goods are relatively cheap. Competitiveness increases so exports
rise and imports go down. The Current Account improves. Initially the CA can worsen when export
and import does not adjust immediately (J-curve).
The Law of One Price says Pi = e Pi*. The same good in different countries should be the same price
when there are no transportation costs or barriers. There are also non-tradable goods.
Purchasing power parity says e = P/P*. This is about general price levels. In practice it is not realistic.
It says that there is depreciation when prices rise. The money becomes worth less.
Relative PPP is about growth rates. Π = dee + π*
(Eus – Eusoud)/Eusoud = πus – πeu
It says that when prices rise more than in foreign, the currency must depreciate.
Relative PPP is more consistent. Nog een keer kijken in het boek
Even though home interest rates are higher, sometimes it is better to make a foreign deposit. This
depends on the expected exchange rate (UIP) or the forward exchange rate (CIP).
Uncovered assumes there is risk-free security, same liquidity and no transaction costs.
In home you get a certain return. In foreign exchange first, then you get an interest rate and then you
exchange back. So it depends on the expected exchange rate.
Eventually there will be an equilibrium. 1 + i = Ee /E (1+i*)
When the left part is higher there will be a capital inflow. Demand for home currency increases so that
E appreciates.
i – i* = (ee – e)/e. This is the expected rate of depreciation.
Covered interest parity is there to cover the exchange rate risk. You get the forward rate f.
i – i* = (f-e)/e
Monetary approach
This is a long run model. Prices are flexible.
Real money demand = liquidity preference
Md/P= L(R,Y)
Ms = Md
P = eP*
