International Finance I

1. International Finance I

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

3. 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

4. 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 Remember defintion of national saving S = Y - C - G

5. NET EXPORTS (BILLIONS OF DOLLARS) (=EXPORTS - IMPORTS) Trade deficit because net 31_01 exports are less than zero (exports are less than imports) BILLIONS OF DOLLARS Investment GAP National saving 0 - 25 - 50 - 75 - 100 - 125 - 150 - 175 1982 1984 1986 1988 1990 1992 1994 1996 1200 1000 800 600 400 1982 1984 1986 1988 1990 1992 1994 1996

6. 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

7. 22_ 07 Nongovernment Share Long run effect of a direct investment stimulus (Japan) R R R R 7.5 7.5 7.5 7.5 5.0 5.0 5.0 5.0 I 2.5 2.5 2.5 2.5 C X NG Y Y Y Y 0.0 0.0 0.0 0.0 62.5 65.0 67.5 12.5 15.0 17.5 -2.5 0.0 2.5 75 80 85 PERCENT PERCENT PERCENT PERCENT (a) Consumption Share (b) Investment Share (c) Net Exports Share (d)

8. 22_ 07 Nongovernment Share Long run effect of a direct savings stimulus (U.S.) R R R R 7.5 7.5 7.5 7.5 5.0 5.0 5.0 5.0 I 2.5 2.5 2.5 2.5 C X NG Y Y Y Y 0.0 0.0 0.0 0.0 62.5 65.0 67.5 12.5 15.0 17.5 -2.5 0.0 2.5 75 80 85 PERCENT PERCENT PERCENT PERCENT (a) Consumption Share (b) Investment Share (c) Net Exports Share (d)

9. 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 

10. The Balance of Payments($Billions in 1996)

11. BILLIONS OF DOLLARS 31_02 Trade balance 50 (net exports) 0 - 50 - 100 Current account - 150 balance - 200 1982 1984 1986 1988 1990 1992 1994 1996

12. 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

13. 31_03 BILLIONS OF DOLLARS 4,500 Foreign assets in U.S. 4,000 3,500 Net debtor 3,000 2,500 U.S. assets abroad Net creditor 2,000 1,500 1,000 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

14. 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

15. 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?

16. 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

17. END OF LECTURE