Ch. 19 Reflection: A Macroeconomic Theory of the Open Economy

Ch. 19 Reflection A Macroeconomic Theory of the Open Economy

Question 1: What are the two types of investment that a nation makes with its savings, and what determines which investment they choose?

Answer A: A nation’s borrowers choose to either invest domestically or in foreign assets. The borrower will invest based on the current exchange rates and the buying power of the dollar.

Answer B: A nation’s savings are also referred to as loanable funds. As our text explains, “Whenever a nation saves a dollar of its income, it can use that dollar to finance the purchase of domestic capital or to finance the purchase of an asset abroad”. Another term for the investment in assets abroad is net capital outflow. One determination of which investment to choose depends on the real interest rate. When real interest rates rise, domestic investments are more profitable, and the net capital outflow is reduced. As well, when real interest rates fall, foreign assets are more popular, and the net capital outflow is increased.

Question 2: Name two common trade policies and how they affect the trade balance? 

Answer A: Two common trade policies are tariffs and import quotas. “Trade policies do not affect the trade balance”. 

Answer B: A trade policy is “a government policy that directly influences the quantity of goods and services that a country imports or exports”. A tariff, which is a tax on an imported good, is one common trade policy. An import quota, which is a limit on the amount of goods allowed to be imported and sold from abroad, is another common trade policy. When these types of trade policies are enforced, the dollar tends to appreciate. When this happens, domestic good become more expensive compared to foreign goods. Because of this, net exports remain unchanged, therefore, “trade policies do not affect the trade balance”.

Question 3: Name two instances of capital flight since 1990 and explain what caused them.

Answer A: Capital flight happened in Mexico in 1994 because of political instability. It happened again in 1998 in Russia when the government defaulted on its debt.

Answer B: Capital flight is the occurrence of “a large and sudden reduction in the demand for assets located in a country”. Capital flight occurred in Mexico in 1994 because of the political instability associated with the assassination of “a prominent political leader”. Therefore, when Americans heard the news of this assassination, many decided to sell their assets in Mexico and reinvest in domestic assets, causing the peso to depreciate and interest rates in Mexico to increase. Another example of capital flight was in 1998 after the collapse of the USSR when Russia defaulted on its debt. When foreign investors in Russia heard this news, they quickly sold their assets in the Russia and reinvested elsewhere. This capital flight also increase interest rates in Russia and depreciated their currency.

Comments

Post a Comment

Popular posts from this blog

Ch. 22 Reflection: The Short-Run Trade-Off Between Inflation and Unemployment

Ch. 22 Reflection: The Short-Run Trade-Off Between Inflation and Unemployment   A good example of the short-run trade-off between inflation and unemployment is described as the Volcker Disinflation. Paul Volcker, chairman of the Fed was put in a tough situation at the end of the 1970s when OPEC had increased the cost of oil by reducing supply. In order to rein in inflation from 10% down to something more reasonable and plateable by the American public, Volcker had to sacrifice high unemployment in order to lower inflation. Volcker achieves this through tough monetary anti-inflation policies or contractionary policies. This was also countering the fiscal policies at the time in which the Reagan administration was increasing budget deficits which expanded aggregate demand and would normally have increased inflation. Because of the fiscal policy at the time, Volcker’s adjustment took the form of Phillips Curve, was eventually expected inflation fell and the Phillips curve shifted...
Read more

Ch. 23 Reflection: 6 Debates Over Macroeconomic Policy

Ch. 23 Reflection: 6 Debates Over Macroeconomic Policy             I really enjoyed this last chapter. I found the debate over whether the government should focus attention on spending or tax cuts to shorten and reduce the impact of a recession very interesting, and I see the benefits to both. Although, I believe the numbers that government spending leads to a “bigger bang for the buck” than tax cuts, as the Obama administration found out from a computer simulation that showed them that each dollar of tax cuts would increase GDP by $.99 but each dollar of government purchases would increase GDP by $1.59! One way that I changed my thinking is that if Americans realized the total impact of a presidential election, in who that president appoints to offices that we don’t elect, like the chairman of the Fed and the Supreme Court justices, then perhaps Americans would be less apathetic about voting and instead show up to the pol...
Read more