ECON 1000 Chapter Notes - Chapter 12: Foreign Portfolio Investment, Real Interest Rate, Tim Hortons
2 May 2018
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ECON 1000
Chapter 12: Open-Economy Macroeconomics: Basic Concepts:
• Trade allows people to produce what they produce best and to consumer the great
variety of goods and services produced around the world
• Closed economy: an economy that does not interact with other economies in the world
• Open economy: an economy that interacts freely with other economies around the
world
The International Flows of Goods and Capital:
• An open economy interacts with other economies in two ways: It buys and sells goods
and services in world product markets and it buys and sells capital assets such as stock
and bonds in world financial markets
The Flow of Goods: Exports, Imports and Net Exports:
• Exports: domestically produced goods and services that are sold abroad
• Imports: foreign-produced goods and services that are sold domestically
• Net epots: the alue of a out’s epots ius the alue of its ipots
• Net epots = Value of out’s epots – Value of out’s ipots
• Trade balance: the value of a natio’s epots ius the alue of its ipots; also alled
net exports
• Trade surplus: an excess of exports over imports
• Trade deficit: an excess of imports over exports
• Balanced trade: a situation in which exports equal imports
The Flow of Financial Resources: Net Capital Outflow:
• Net capital outflow: the purchase of foreign assets by domestic residents minus the
purchase of domestic assets by foreigners
• Net capital outflow = Purchase of foreign assets by domestic residents – Purchase of
domestic assets by foreigners
• When a Canadian buys stock in the Mexican phone company, the purchase raises
Canadian net capital outflow, when a Japanese resident buys a bond issued by the
Canadian government, the purchase reduces Canadian net capital outflow
• The flow of capital abroad takes two forms:
1. If Tim Hortons opens a fast-food outlet in Russia, that is an example of foreign direct
investment
2. If a Canadian buys stock in a Russian corporation, that is an example of foreign portfolio
investment
• In the first case, the Canadian owner is actively managing the investment, whereas in
the second case the Canadian owner has a more passive role
• In both cases, Canadian residents are buying assets located in another country, so both
purchases increase Canadian net capital outflow
• The net capital outflow (net foreign investment) can be either positive or negative
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• When it is positive, domestic residents are buying more foreign assets than foreigners
are buying domestic assets, capital is said to be flowing out of the country
• When the net capital outflow is negative, domestic residents are buying less foreign
assets than foreigners are buying domestic assets, capital is said to be flowing into the
country
• When net capital outflow is negative, a country is experiencing a capital inflow
• Important variable that influence net capital outflow:
o Real interest rates being paid on foreign assets
o Real interest rates being paid on domestic assets
o Perceived economic and political risks of holding assets abroad
o Government policies that affect foreign ownership of domestic assets
The Equality of Net Exports and Net Capital Outflow:
• Net epots easue a ialae etee a out’s exports and its
imports
• Net capital outflow measures an imbalance between the amount of foreign
assets bought by domestic residents and the amount of domestic assets
bought by foreigners
• Net capital out flow (NCO) always equals net exports (NX)
• NCO = NX
• Every transaction that affects one side of this equation must also affect the
other side by exactly the same amount
• Ex. the Canadian aircraft maker, sells some planes to a Japanese airline, in this sale, a
Canadian company gives planes to a Japanese company, and a Japanese company gives
yen to a Canadian company, two things have occurred simultaneously
• Canada has sold to a foreigner some of its output (the planes), and this sale increases
Canadian net exports, Canada has acquired some foreign assets (the yen), and this
auisitio ieases Caada’s et apital outflo
• The equality of net exports and net capital outflow follows from the fact that every
international transaction is an exchange
• When a seller country transfers a good or service to a buyer country, the buyer country
gives up some asset to pay for this good or service, the value of that asset equals the
value of the good or service sold
• When we add everything up, the net value of goods and services sold by a country (NX)
must equal the net value of assets acquired (NCO)
• When a nation is running a trade surplus (NX > 0), it is selling more goods and services to
foreigners than it is buying from them, with the foreign currency it receives from the net
sale of goods and services abroad it must be using it to buy foreign assets, capital is
flowing out of the country (NCO > 0)
• When a nation is running a trade deficit (NX < 0), it is buying more goods and services
from foreigners than it is selling to them it is financing the net purchase of these goods
and services in world markets by selling assets abroad, capital is flowing into the country
(NCO < 0)
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Saving, Investment, and Their Relationship to the International Flows:
• A atio’s saig ad iestet ae uial to its log-run economic growth
• National saving is the income of the nation that is left after paying for current
consumption and government purchases
• National saving (S) equals Y − C − G
• Net exports (NX) also equal NCO, we can write this equation as
• S= I + NCO
• Saving = Domestic Investment + Net capital investment outflow
• When Canadian citizens save a dollar of their income for the future, that dollar can be
used to finance accumulation of domestic capital or it can be used to finance the
purchase of capital abroad
• Saving, investment, and international capital flows are inextricably linked
• Whe a atio’s saig eeeds its doesti iestet its et apital outflo is
positive, indicating that the nation is using some of its saving to buy assets abroad
• When a atio’s doesti iestet eeeds its saig its et apital outflo is
negative, indicating that foreigners are financing some of this investment by purchasing
domestic assets
The Prices for International Transactions: Real and Nominal Exchange Rates:
Nominal Exchange Rates:
• Nominal Exchange Rate: the rate at which a person can trade the currency of one
country for the currency of another
• Ex. if you go to a bank, you might see a posted exchange rate of 80 yen per dollar, if you
give the bank one Canadian dollar, it will give you 80 Japanese yen; and if you give the
bank 80 Japanese yen, it will give you one Canadian dollar
• Appreciation: an increase in the value of a currency as measured by the amount of
foreign currency it can buy
• Depreciation: a decrease in the value of a currency as measured by the amount of
foreign currency it can buy
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find more resources at oneclass.com
Document Summary
The flow of goods: exports, imports and net exports: exports: domestically produced goods and services that are sold abroad. Canadian net capital outflow, when a japanese resident buys a bond issued by the. In the first case, the canadian owner is actively managing the investment, whereas in the second case the canadian owner has a more passive role. The prices for international transactions: real and nominal exchange rates: German beer per case of canadian beer: real exchange rate = nominal exchange rate x domestic price. A first theory of exchange-rate determination: purchasing-power parity: purchasing-power parity: a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries. It tells us that the nominal exchange rate between the currencies of two countries depends on the price levels in those countries. Some consumers prefer german beer, and other prefer canadian beer, but consumers tastes can change over time.
