Depreciation and Trade Balance What is the impact of depreciation on trade? –Import goods cost...
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Depreciation and Trade Balance • What is the impact of depreciation on trade? – Import goods cost more – Exports increases as they are cheaper abroad – Imports decrease as they are expensive at home • Overall impact on Net Exports (X-M) is that it increases. • Marshall-Lerner Condition: substitution effect dominates income effect
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Transcript of Depreciation and Trade Balance What is the impact of depreciation on trade? –Import goods cost...
Depreciation and Trade Balance
• What is the impact of depreciation on trade?– Import goods cost more– Exports increases as they are cheaper abroad– Imports decrease as they are expensive at home
• Overall impact on Net Exports (X-M) is that it increases.
• Marshall-Lerner Condition: substitution effect dominates income effect
Depreciation and Trade Balance• Change in net export increases demand for
domestic goods• Does reducing the trade deficit increase
output?– In the short-run it does– In the long-run not necessarily
• Fiscal contraction may compensate short-run impact of depreciation (G)
• Shortcomings: a) source of depreciation; b) why we care for GDP equilibrium
Depreciation and Trade Balance
• The J-Curve: compares impact effect of depreciation and path to new equilibrium– On impact nominal imports increase (due to
price effect)– Then Marshall-Lerner condition kicks in
• There is a lag between real exchange rate movements and trade balance (about 1year)
Saving = Investment
• In a Closed Economy domestic savings equals investments
• In an Open Economy Investmet equals “Total Savings”:– Private Savings– Government Savings– Foreign Savings
Saving = Investment
• Y = C + I + G +X – M– Since C = Y – S – T then
• Y = Y – SP – T + I + G + X – M– Y cancels out; rearrange the rest and we get
• (SP) + (T-G) + (M-X) = I– Private savings (SP) plus– Government savings (T-G) plus– Foreign Savings (balance of payments)
Saving = Investment
• Investment increase either with private savings; government savings; or trade deficit
• Gov deficit affects either investment or private savings or creates a trade deficit
• High private saving rate results either in high investment ; trade surplus; or gov. surplus
• S=I also means that gov deficit does not lead to trade deficit
U.S. Trade Deficit• US X/GDP is quite constant through the years• US M/GDP has been increasing through time• Increasing trade deficit ($856bil; 6% of GDP);
half of world savings• US has been growing more than EU and Japan• Trade deficit increase even with appreciation• Answer: increasing foreign savings• During depreciation investment has stayed
constant while domestic saving has fallen. Why?
