What is ? Sometimes called “open economy macro” Typical topics include –trade deficit –exchange rate policy--flexible, fixed, single currency (such as Euro)?

Haven’t we covered the trade deficit and exchange rate determination before? Yes (so we will do some useful review), and No, focus is more on international relationships between countries and on exchange rate policy (fixed versus flexible) Recall that international trade (comparative advantage, tariffs, etc) was covered in earlier lectures

Determinants of the overall trade deficit Recall spending-GDP identity Y = C + I + G + X Y = GDP C = consumption I = investment G = government purchases X = net exports Or S - I = X X < 0 (trade deficit), if S < I as in U.S. X > 0 (trade surplus), if S > I as in Japan

31_ BILLIONS OF DOLLARS NET EXPORTS (BILLIONS OF DOLLARS) (=EXPORTS - IMPORTS)  25  50  75  100  125  150  175 Trade deficit because net exports are less than zero (exports are less than imports) Investment National saving GAP

Example of relevance for policy: U.S. international relations with Japan Policy problem: Japan had (has) a trade surplus and U.S. had (has) a trade deficit What to do about it, if anything? Trade restrictions are not the answer Must change S or I in the U.S. and Japan Let’s use SAM to show how it works

Long run effect of a direct investment stimulus (Japan) 22_ R C Y (a) Consumption Share R I Y (b) Investment Share R NG Y (d) R X Y (c) Net Exports Share -2.5 PERCENT Nongovernment Share

Long run effect of a direct savings stimulus (U.S.) 22_ R C Y (a) Consumption Share R I Y (b) Investment Share R NG Y (d) R X Y (c) Net Exports Share -2.5 PERCENT Nongovernment Share

Developing a U.S. policy position President to meet with Japanese prime minister –Options (1) tell PM to use policy to raise I (2) tell PM to use policy to lower S President favors (1) –Decides over lunch with CEA Basic economic principles inform decision

The Balance of Payments ($Billions in 1996)

31_02 Current account balance BILLIONS OF DOLLARS 50 0   100  150  200 Trade balance (net exports)

Capital Account The the amount of funds (new debt or equity) needed to finance the current account deficit in any year For example, in 1996 the U.S. increased its net debtor position by $147 billion –note that the current account was $147 billion

31_03 BILLIONS OF DOLLARS ,500 4,000 4,500 3,000 2,500 1,500 1,000 2,000 Foreign assets in U.S. U.S. assets abroad Net debtor Net creditor

Deficits were also large at an earlier stage of U.S. history In the 19th century the U.S. ran large international trade deficits for many years The gap between S and I was large (I>>S) –Railroads across country –Leland Stanford  Stanford University! Funds were lent to the United States by Europeans Similar stories in Argentina and Australia

Bilateral deficits always a part of world trade preventing them by trade restrictions is harmful they have little to do with trade barriers why discussed so much?

Sector deficits Focus on trade within a sector or industry Example, U.S. runs a deficit in “baseball” caps and runs a surplus in “higher education” Like bilateral deficits, –micro rather than macro –do not reflect trade barriers Overall deficits are macro

END OF LECTURE