Macroeconomic Analysis 2003
Competitiveness
Blanchard (19-20) Mankiw (12-13) M &S (20)
Lecture 19
1
A Competitive Economy
•
•
•
•
Exports more than imports
Has lower production cost
Has a stable exchange rate
Long run fundamentals are honoured
–
–
–
–
Budget is balanced over time
trade is balanced over time
Domestic and External Debts are reasonable
Money supply is controlled and aligned to the
growth rate of GDP
– real interest rates are positive
Lecture 19
2
Determinants of Net Export
Net export function
NX  X  eM




NX  X Y *,e  eM Y ,e
NX = net exports
X = exports
e = nominal exchange rate
M = imports
Y* = income level in the foreign country
Y = income level at home
Three sources of changes in net exports:
1. Exports 2. Imports and 3. Exchange rate
Lecture 19
3
J-Curve Hypothesis: Impact of Devaluation on Net Exports
Export creation and
Import substitution or
demand switching takes time
Net
Exports
o
Time
Lecture 19
4
Marshall-Lerner condition
Devaluation is effective if
ex  em  1
Devaluation is ineffective if
ex  em  1
Devaluation has no effect in trade balance
ex  em  1
ex
em
is elasticity of export
is the elasticity of imports
Lecture 19
5
Numerical Example of the Marshall-Lerner Condition
Change in net exports is zero if the sum of exchange
rate elasticity of exports and imports equals 1.
Net export increases if this sum is greater than one.
Net export decreases if this sum is less than one.
Example: There is a devaluation
Export elasticity is 0.9
import elasticity if –0.8
Net export rises because 0.9-(-0.8) =1.7%.
Lecture 19
6
Derivation of Marshall-Lerner condition
NX  X  eM  0
e 1
1
M


X M and X e
From
Change in net export
NX  X  eM  Me
Divide both sides by X
NX  X  e M  M e
X
X
X
X
NX  X  M  e  0
e
X
X
M
Marshall-Lerner Condition
X e  M e  1
e
X e
M
Lecture 19
7
Determinants of Output in an Open Economy
1. Aggregate demand again is determined by
consumption, investment, government spending and
net exports. Aggregate supply depends on capital
stock and labour force.
2. Disposable income determines the consumption.
3. Real interest rate determines the level of investment.
4. Tax revenues depend on national income.
5. Exports depend on foreign income and the real
exchange rates and imports depend on domestic
income and the real exchange rate.
6. Net exports depend on the real exchange rate which
in turn in determined by domestic and foreign price
level and the nominal exchange rate.
7. Nominal interest rate is determined in the money
market.
8. Capital inflow/outflow is determined by the
difference in the domestic and foreign real interest
rates.
Lecture 19
8
Open Economy Macroeconomic Model
National income
*
f
eP
e
Y  C(Y T )  I (Y , i  )  G  NX (Y ,Y ,
)
P
M
 Li, Y 
P
Money market:
 r   (3)
eP *
 
P

*
NX

KF
r

r
Balance of payment:
e


Y

Y


P

P
Aggregate supply:

Natural rate of output: Y  F K , L
Lecture 19
(2)
e
Real and nominal interest rates: i
Real exchange rate:
(1)


(4)
(5)
(6)
(7)
9
Seven endogenous variable: Y, Y , i, r, ε, P, e.
E
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Lecture 19
x
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p
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f
=
t
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=
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l
Pe
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=
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=
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T
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:
e
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=
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M
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d
.
10