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• carmenng1990

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Open-economy: given world interest rate r , S – I = CA = NX Absorption A = C + I + G CA = NX + NFP + NUT (net unilateral transfers; not good/asset) (1) Net investment income (previously acquired assets abroad) (+) American owns British stock => dividend flow into U.S. (+) Foreign subsidiary of US firms => profit flow into U.S. (−) Britain holds U.S. stock => dividend flow out of U.S. (−) U.S. subsidiary of foreign firm => profits flow out of U.S. (2) Net payments to labor (very small for U.S.) NUT: (−) foreign aid (−) foreigners in U.S. sending money to families abroad (+) gifts from abroad (+) remittances from Americans abroad CA + KFA = 0 (trade//capital flows; CA>0 -> buy assets -> KFA Nat’l Savings ↓ -> CA deficit ↑ d d d d d L. Econ: S ↓ -> S + S For < I + I For -> interest rate ↑ enom = #FC / #HC (floating v. fixed/pegged; appreciate v. revalue) e = P * enom / Pfor (but strong PPP, where e = 1, doesn’t hold!) Real exchange rate depreciation (exports more competitive abroad, Net exports (NX = X-M) should rise…but) J-curve (SR switch from (higher-price) imports to (lower-price) domestic may be slow -> NX may fall initially as real value of imports relative to exports increases) Currency Mkt: supply (by domestic holders) & demand (foreign) ↑ (perceived) PVLR -> ↑ demand for goods/imports -> NX↓ ↓ dom. int rates -> dom. assets sell-off -> ↓ currency demand -> ↓ exchange rate -> ↑NX UIP:

(1  iUK )  (1  i)

CIP:

(1  i for )  (1  i)

e enom ,t 1

enom,t f nom,t 1 enom,t

Currency Crisis (currency is overvalued, epeg > efv/nom): (1) To prevent devaluation, central bank buys currency (MS↓) -> LM up -> Y↓ and r↑ -> (2) debt burden increased for those who borrowed in foreign currency -> uncertainty -> ↓financing -> aggregate C and I↓ -> IS left -> gov’t spending↓ b/c of deficits -> IS more left -> further effort to restrict devaluation -> LM up more -> much lower Y! Recovery: ↓enom -> NX↑ -> IS back right -> central bank ↑MS -> LM back down Y = A*F(K, N) (growth can come from all 3 variables) Solow Growth Model: (assume: no taxes/gov’t spend, labor mkt is stable in LR, money is neutral in LR) y = Y/N; c = C/N; k = K/N y = output-labor ratio; k = the capital-labor ratio Y/N = A*F(K/N, N/N) = A*F(K/N, 1) = A*f(k) Assume: f(0) = 0, f’(k) > 0, f’’(k) < 0 Holding A constant, LR equilibrium (A can be excluded): * * (n + d)k = sAf(k ) * * * * * * * * y = Af(k ); c = (1 – s)Af(k ) = f(k ) – (n + d)k ; i = (n + d)k

or ifor = i + (eenom,t+1/enom, t –1) IMPLIES: (f nom = eenom)

Weak PPP (LR): ∆enom/enom = pfor – p (low inflation -> strong $$$) ∆e/e = ∆enom/enom + π - πfor Open Econ. ISLM -> Only change is IS -> I = S -> S – I = NX Factors that shifted IS before have same effect; all factors that shift NX (except changes in income) also shift IS Gov’t Purchase ↑ -> IS out -> Y↑ and r↑ -> enom (? In SR) -> NX↓ Foreign country: NX↑ -> IS out -> Yfor ↑ and rfor ↑ LR: LM shifts up for both dom. and foreign (r and rfor ↑) If budget deficit persists and r > rfor -> e↑ -> NX↓ -> IS down -> back to old equilibrium Monetary Contraction -> LM up -> Y↓ and r↑ -> enom↑ -> NX (? Delayed effect from enom (J-curve), so NX prob.↑ initially) Foreign: NX↓ -> IS in -> Yfor and rfor↓ LR: firms decrease prices -> LM shifts back down -> NX↑ -> P↓ and Pfor unchanged -> e re-depreciates -> back to FE, but ↑enom Fixed Ex. Rate Regime: Central bank = no indep. monetary policy Currency Devaluation -> enom↓ permanently -> e↓ (for given P’s) -> NX↑ (pressure on IS to move out) -> bank ↑MS to prevent rise in r -> LM shifts down and right

(savings rate or productivity ↑) (population or dep. growth causes straight line to pivot left) Golden Rule capital-labor ratio kg at line tangent to curve (consumption per capital only increases up to that pt.) Only changes in s, f, n, or d can impact steady state Only (∆A = g > 0) can increase long run growth of GDP/capita *

Temporary (k < k ) vs. permanent differences (↓s, ↓A, ↑d…) Conditional Convergence: countries w/ diff. s, n, d, and A * converge to different k -> those with low levels of k relative to * their k will grow faster! Taxes of Solow Model: G = t × Y (income tax rate) s×(1-t)Af(k*) = (n+d)k* (taxes equiv. to ↓s or ↓A) Limits to Solow: ↓marginal returns to K, ∆A missing Causes of Productivity Growth: human capital accumulation, R&D, better infrastructure, trade and foreign direct investment (FDI) Also low barriers to entrepreneurial activity/tech. adoption Endogenous Growth Model: ΔY/Y = ΔK/K = g = sA – d ΔY/Y = ΔA/A + aKΔK/K + aNΔN/N