Lecture 19: The Goods Market in the Open Economy
MIT OpenCourseWare
48 min, 17 sec
A detailed exploration of short-term open economy dynamics and the role of exchange rates.
Summary
- Review of the short-term model, integrating open economy concepts focusing on goods and financial markets.
- Introduction of key relative prices: real exchange rate and its impact on exports and imports.
- Analysis of how domestic and foreign demands for goods affect the domestic economy.
- Elaboration on the uncovered interest parity condition and its implications for investment decisions.
- Discussion on policy tools available in an open economy, such as fiscal policy adjustments and exchange rate manipulation.
Chapter 1
Transitioning from previous concepts to the open economy model.
- Returning to short-term models, now within the context of an open economy.
- Completion of previous lecture's concepts on openness and key relative prices.
- Real exchange rate defined as a tool for comparing domestic and international goods, adjusted for currency.
Chapter 2
Explaining the real exchange rate and effects of its appreciation.
- Real exchange rate appreciation implies domestic goods becoming more expensive relative to international goods.
- Depreciation of real exchange rate causes domestic goods to become cheaper, affecting imports and exports.
Chapter 3
Discussing capital account openness and financial market implications.
- Openness in financial markets allows for investment in domestic or foreign assets.
- Decision-making for investment compares expected relative returns, considering risk and currency appreciation or depreciation.
Chapter 4
Delving into the uncovered interest parity condition.
- The condition states that expected returns on domestic and foreign bonds should align after adjusting for expected currency changes.
- This parity ensures indifference in investment decisions between domestic and foreign bonds.
Chapter 5
Differentiating between demand for domestic goods and domestic demand for goods.
- Demand for domestic goods includes domestic demand minus imports, adjusted for the exchange rate.
- This distinction becomes crucial when considering the impact of international trade on domestic production.
Chapter 6
Analyzing the functions of exports and imports in aggregate demand.
- Exports are assumed to increase with foreign output and decrease with real exchange rate appreciation.
- Imports increase with domestic output and with real exchange rate appreciation.
Chapter 7
Finding equilibrium in the goods market of an open economy.
- Equilibrium output determined by intersection of ZZ curve (demand for domestic goods) with 45-degree line.
- Influence of government expenditure and foreign output on ZZ curve and trade balance.
- Depreciation of currency as a tool to influence trade balance.
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