Mgec61 Note - Chapter 13

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MGEC61 – International Economics: Finance


International finance is a study of problems and policies of an open economy.

International finance studies the issues like unemployment, savings, trade imbalances, money and price levels (include exchange rates).

Organization of the course
1) Introduction – chapter 13
2) Interest rate parity (how exchange rate is determined by the flows of capital) and exchange rate overshooting – chapters 14 & 15
3) Purchasing power parity and the exchange rate in the long run (how exchange rate is determined by the flows of goods and the determinants of exchange rate in the long run) – chapter 16
4) The DD-AA model (the model that explains how exchange rate and output are determined in general equilibrium setting) – chapters 17 &18

Flexible exchange rate – chapter 17

Fixed exchange rate – chapter 18

5) International macroeconomic policy – chapters 19 & 21

Arguments for and against flexible exchange rates – chapter 19

Interdependence of macroeconomic policies – chapter 19

Arguments for and against common currency – chapter 21

MGEC61 – Chapter 13

© Iris Au


Chapter 13: National Income Accounting and the Balance of Payments
The National Income Identity for an Open Economy

The national income identity for an open economy is:
Output (Y) = C + I + G + (EX – IM)

A country’s current account (CA) balance shows the difference between exports of goods and services and imports of goods and services (including net income on foreign investments), plus net unilateral transfer.
CA = EX – IM + Net unilateral transfer
Foreign aid received – Foreign aid gave out

If net unilateral transfer = zero, CA = EX – IM, then:
Y = C + I + G + CA

Saving and the Current Account

National saving (S): the amount of output that is not devoted to private consumption and government spending, i.e., S = Y – C(Y – T) –…...

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