KOOTHS | BiTS: International Economics (winter term 2014/2015) 1
International Economics
Prof. Dr. Stefan KoothsBiTS Berlin
(winter term 2014/2015)www.kooths.de/bits-ie
KOOTHS | BiTS: International Economics (winter term 2014/2015) 2
Contact data
Prof. Dr. Stefan KoothsDeputy Head of the Forecasting CenterKiel Institute for the World Economy
Office BerlinIn den Ministergärten 810117 Berlin030/2067-9664
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The Kiel Institute for the World Economy
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Outline
1. Introduction and Overview
2. Recording Cross-border Economic Activity
3. The Pure Theory of International Trade
4. Trade Policy: Free Trade vs. Protectionism
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis
7. Summary: The Key Lessons Learnt
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Outline
1. Introduction and Overview Motivation, key questions, and methodology Course scheme
2. Systemizing and Recording Cross-border Economic Activity
3. The Pure Theory of International Trade
4. Trade Policy: Free Trade vs. Protectionism
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis
7. Summary: The Key Lessons Learnt
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Global production and international trade
Average growth:GDP: 3.4 percentTrade: 5.6 percent
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Drivers of Globalization (overview)
Liberalization of world trade Liberalization of cross-border capital flows Collapse of centrally-planned economies Increased political/social stability Improved transportation infrastructure Progress in telecommunication systems/internet technologies Creation of economic blocs (e.g. EEC/EU, NAFTA, MERCOSUR) Spread of technological know-how via FDI Better education for more people
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Effects of Globalization (overview)
Generally: More choices (deeper markets) More competition on world markets Increased number of tradable goods and services More alternatives for production sites
(globally integrated value-added chains) Accelerated structural change/more innovations
(pressure on domestic labor markets) Regulatory arbitrage, pressure on tax and transfer systems
(less latitude for national policies) Intensified international dependencies
Net gains, but domestic winners and losers (preview)
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Why „International Economics“ is different (and why it is not)
Key economic questions (not specific to IE)» (International) division of labor» (International) allocation of production factors» Uniform microeconomic foundations and macroeconomic analysis
Country borders and the nation state» Factor mobility (labor, capital)» Legal frameworks, fiscal policy» National money and exchange rate systems
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Economics:Analysis of economic activity (= coping with scarcities)
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International Economics:Analysis of cross-border economic activity
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BUT: Do country borders always matter?
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Methodological individualism
General method» Individuals as point of departure for economic analysis» Explaining social processes via actions of involved persons
Individuals …» … are diverse» … have exogenous preferences» … are capable of acting on their own» … follow their vested interest
Subjectivism» Individual preferences» No scientific inter-subjective comparisons of utility
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Key first insights from methodological individualism
Trade = exchange of goods or services» Two-sided human interaction (social cooperation)» Based on voluntary contracts (implies mutual benefits)Net gains from trade for both parties (no zero-sum game)
Pitfalls from aggregation/collectivist perspectives» Countries do not trade with each other, only individuals/firms do» Countries do not compete with each other, only individuals/firms do
- Competitiveness is a relative concept- Countries (economic areas) consist of multiple markets- Each market comprises both the supply side and the demand side„Competitiveness“ not applicable to country level
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Outline
1. Introduction and Overview Motivation, key questions, and methodology Course scheme
2. Recording Cross-border Economic Activity
3. The Pure Theory of International Trade
4. Trade Policy: Free Trade vs. Protectionism
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis
7. Summary: The Key Lessons Learnt
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Reading
Literature» Dieckheuer, G. (2001): “Internationale Wirtschaftsbeziehungen”, 5. Aufl., München/Wien.» Eibner, W. (2006): “Understanding International Trade: Theory & Policy/Anwendungsorientierte
Außenwirtschaft: Theorie & Politik”, Oldenbourg Verlag: München/Wien.» Hazlitt, H. (2008): “Economics in One Lesson”, Ludwig von Mises Institute: Auburn/Alabama.
[https://mises.org/books/economics_in_one_lesson_hazlitt.pdf]» Kooths, S. and B. van Roye (2012): “Euro Area: Single Currency – National Money Creation”, Kiel
Working Papers, No. 1787, Kiel.» Pugel, T, A. (2012): “International Economics”, 15th Edition, McGraw-Hill: New York.» Snower, D., J. Boysen-Hogrefe, K.-J. Gern, H. Klodt, S. Kooths, C.-F. Laaser, C. Reicher, B. van Roye, J.
Scheide and K. Schrader (2013): “The Kiel Policy Package to Address the Crisis in the Euro Area”, Kiel Policy Brief, No. 58a, Kiel.
Course website: www.kooths-de/bits-ie
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Outline
1. Introduction and Overview
2. Recording Cross-border Economic Activity The Balance of Payments (BoP) The International Investment Position (IIP)
3. The Pure Theory of International Trade
4. Trade Policy: Free Trade vs. Protectionism
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis
7. Summary: The Key Lessons Learnt
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CAPITAL AND FINANCIAL ACCOUNT
CURRENT ACCOUNT
Types of cross-border transactions
Trade flows» Goods (merchandise)» Services
Cross-border incomes(compensation for use of production factors)» Labor: Compensation of employees» Capital: Investment income
Transfers» Current transfers (regularly) » Capital transfers (one-off)
Financial transactions» Nonofficial: Direct/Portfolio/Other investment» Central bank: Changes in official international reserves
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Accounting principles:Credit and debit items (double-entry bookkeeping)
Credit item (measured with a positive sign/entry on the left side) …» … results from a transaction for which the country must be paid. It sets
up the basis for a payment by a foreigner into the country – that is, it creates a monetary claim on a foreigner.
Debit item(measures with a negative sign/entry on the right side) …» … results from a transaction for which the country must pay. It sets up
the basis for a payment by the country to a foreigner – that is, it creates a monetary liability against a foreigner.
Double-entry system(sum of all credit entries = sum of all debit entries)» BUT: Statistical discrepancies („errors and omissions“)
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Valuation: cif vs. fob
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Key “Balance of Payments” concepts
Flow-oriented framework for cross-border transactions» Specific time period (year, quarter, month)» NOT: Stocks (“balance sheet”)
Time of recording» Accrual principle» NOT: Actual Payment
People» Residents vs. Non-Residents» NOT: Nationals vs. foreigners (nationality does not matter)
Focus: Reporting country vs. RoW (= rest of the world)
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The consolidated BoP account
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Current account vs. Capital and financial account
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More detailed BoP subaccounts
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The detailed BoP structure (IMF BoP Manual)
IMF Balance of Payments Manualhttp://www.imf.org/external/pubs/ft/bopman/bopman.pdf
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Official reserve assets and the role of the central bank
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Real-life BoPs
Statistical Discrepancies=Net Errors and Omissions=Balance on Unclassified Transactions
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Example: US Balance of Payments (2010, $ billions)
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Interpreting BoP balances (BoP and National Accounts)
Goods and services balance / trade balance (NX)» Net exports of both goods and services
Current account balance (CA)» Net credits on the flows of goods, services, income, current transfers
Financial account balance, exl. official reserves (FA)» Net credits involving changes in
nonofficial foreign financial assets and liabilities Overall balance / official settlements balance (B)
» Current account balance + (nonofficial) financial account balance [+ statistical discrepancy] = Increase of official reserve assets
Link to National Accounts» NX GDP» CA GNI» CA + net capital transfers Net external lending
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Does a trade deficit reduce GDP?
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Accounting exercise (Reporting country: USA)
(1) At the end of the year, Northern Illinois (a U.S. utility company) buys $34 million in natural gas from a Canadian firm. It does not pay in cash immediately, but instead issues a promissory note saying it will pay the bill (plus interest that will accrue over time) one year later.
(2) Brazilian soccer fans spend $6 million as tourists in the U. S. during a soccer tournament, and they pay for their hotels, meals, and transportation by using the deposits that they have at a New York bank.
(3) The U.S. Treasury pays $25 million in interest on its past borrowing from Swiss investors, paying with checks on a New York bank.
(4) The U.S. monetary authority (Fed) in its official role becomes concerned that the exchange rate value of the dollar may appreciate against the Japanese yen. It decides to purchase yen-denominated bank deposits from a major Tokyo bank and pay by transferring $15 million of its New York bank deposits to this Tokyo bank.
(5) The U.S. government gives $8 million in foreign aid to the government of Egypt in the form of wheat from U.S. government stockpiles.
(6) Mexican immigrant workers in the U.S. send $2 million from their bank accounts at a Phoenix-based bank as remittances to their families in Mexico.
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Outline
1. Introduction and Overview
2. Recording Cross-border Economic Activity The Balance of Payments (BoP) The International Investment Position (IIP)
3. The Pure Theory of International Trade
4. Trade Policy: Free Trade vs. Protectionism
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis
7. Summary: The Key Lessons Learnt
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Linking BoP and IIP
Stocks (IIP) vs. flows (BoP Transaction-based flows vs. revaluations of stocks
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Germany: Current account, capital transfers, and IIP
-50
0
50
100
150
200
0
200
400
600
800
1000
1200
1400
1600
1800
2000
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Balance on Current Account (rhs) Net Errors and Omissions (rhs) Net Capital Transfers
IIP Transaction-based IIP (1992 ff.)
Annual data.Source: Deutsche Bundesbank, IfW calculations.
Bn. Euro Bn. Euro
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade
General analysis of cross-border trade Reasons for inter-industry trade:
Absolute and comparative advantage Causes and consequences of cost differences:
The role of factor endowments and factor proportions “Imperfect” competition and intra-industry trade
4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open
Macroeconomy6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Four basic questions about cross-border trade
Causes:What determines which products are exported and imported?
Impact:How does trade affect production and consumption in each country?
National gains:How does trade affect the economic well-being of each country?
Intra-national winners and losers :How does trade affect the distribution of economic well-being among various groups within a country?
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Categories of trade
Non-availability (trade in commodities) Inter-industry trade (specialization) Intra-industry trade
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Product markets: General assumptions, demand and supply, consumer and producer surplus, elasticities
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Opening of trade: National and international markets
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Arbitrage and free-trade equilibrium
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Terms of trade
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Four basic answers to trade
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade
General analysis of cross-border trade Reasons for inter-industry trade:
Absolute and comparative advantage Causes and consequences of cost differences:
The role of factor endowments and factor proportions “Imperfect” competition and intra-industry trade
4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open
Macroeconomy6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Adam Smith: Theory of absolute advantage
» Maximum number of working hours: 10 (millions, billions, …)» Production and consumption possibilities without trade
(self-sufficiency)?» Consumption possibilities with trade and specialization
(division of labor)?
Working hoursper ton of wheat
Working hoursper barrel of wine
Country A 2 5
Country B 2,5 4
Adam Smith (1723—1790)An Inquiry into the Nature and Causes
of the Wealth of Nations, 1776
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David Ricardo:Opportunity cost and theorem of comparative advantage
» Maximum number of working hours: 10 (millions, billions, …)» Production and consumption possibilities without trade
(self-sufficiency)?» Any chance for mutually beneficial trade (division of labor)?
David Ricardo (1772—1823)On the Principles of Political Economy and Taxation, 1817
Working hoursper ton of wheat
Working hoursper barrel of wine
Country A 2 5
Country B 1 4
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Production-possibility curve
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Exchange rate and terms of trade
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Mercantilism and unbalanced trade
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Complete vs. incomplete specialization: Constant vs. increasing marginal cost
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Production conditions, preferences and trade patterns
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Trade effects and gains from trade
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Country size and relative international winners
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade
General analysis of cross-border trade Reasons for inter-industry trade:
Absolute and comparative advantage Causes and consequences of cost differences:
The role of factor endowments and factor proportions
“Imperfect” competition and intra-industry trade
4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open
Macroeconomy6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Factor proportions and factor endowments
Factor proportions» Factor intensity used in production of goods» Labor-intensive good:
Ratio of labor to other factors is high relative to other goods(share of labor costs is high relative to other goods)
Factor endowments» Available factor resources within a country» Labor-abundant country:
Ratio of labor to other factors is high relative to the rest of the world
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Shares of the world‘s factor endowments (2007/2010)
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The Heckscher-Ohlin theory and income distribution
Two countries, two factors, two goods (2-2-2 model) Fixed and fully employed factor supplies
» Mobile between sectors within each country» Immobile between countries
Same consumption patters in both countries Same (constant-return-to-scale) production technologies in
both countriesTrade explanation by H-O
» Differences across countries in the relative availability of factors» Differences across products in the use of these factorsA country exports products that use its relatively abundant factor(s)
intensively and imports products that use its relatively scarce factors intensively
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Short-run and long-run effects:National losers and winners (1/2)
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Short-run and long-run effects:National losers and winners (2/2)
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The Stolper-Samuelson theorem and factor price equalization
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The Rybczynski-theorem
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The Leontief-paradox and empirical evidence
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade
General analysis of cross-border trade Reasons for inter-industry trade:
Absolute and comparative advantage Causes and consequences of cost differences:
The role of factor endowments and factor proportions “Imperfect” competition and intra-industry trade
4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open
Macroeconomy6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Intra-industry trade (overview)
Intra-industry trade» Exports and imports in the same product category
Main drivers and explanations» Product differentiation (monopolistic competition)» Substantial internal scale economies (global oligopolies)» External scale economies (regional spill-overs, industry clusters)
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Measuring intra-industry trade
United States, selected products (2009)
Average percentage IIT-shares in non-food manufactured products
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Internal and external scale economiesand complete specialization
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Monopolistic competition
Preferences for variety and product differentiation Some internal scale economies (decreasing average cost) Easy market entry and exit in the long runMild form of “imperfect” competition
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Global oligopolies
Substantial internal scale economies (few large firms) Path-dependency for firm locations Oligopoly pricing (interdependence, game theory)Stronger form of “imperfect” competition
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External scale economies: Industry clusters
Spill-overs and regional clusters:Size of the entire industry in one location matters» Home market» Path-dependency, luck» Government interventions
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Summary: Gains and losses from international trade
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism
Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade policy Free trade: Pros and cons
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Goals of protectionism
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Mercantilism
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Tariffs vs. nontariff barriers to trade
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism
Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade policy Free trade: Pros and cons
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Tariff as a tax on imports
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Types of custom duties
Specific tariff Ad valorem tariff
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Effect on domestic producers
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Effect on domestic consumers
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Government revenues
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Net national effect
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Terms-of-trade effect: Small vs. large countries
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Nationally „optimal“ tariffs
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism
Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade policy Free trade: Pros and cons
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Types of nontariff barriers
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Import quotas: Small country analysis
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Allocating import licenses
Fixed favoritism Auction Resource-using procedures
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Import quotas: Large country analysis
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„Voluntary“ export restraints
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Other nontariff barriers
Product standards Domestic content requirements Government procurement
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism
Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade policy Free trade: Pros and cons
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Dumping vs. fair market value
„Normal“ value» Comparative (prices charged in domestic market)» Cost-based (selling below average cost)
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Types of dumping
Predatory Cyclical Seasonal Persistent (price discrimination)
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Small exporting country analysis
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Large exporting country analysis
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Retaliation
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Strategic trade policy: Boing vs. Airbus (1/2)
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Strategic trade policy: Boeing vs. Airbus (2/2)
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Outline
1. Introduction and Overview2. Systemizing and Recording Cross-border
Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism
Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade
policy Free trade: Pros and cons
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Stages of economic integration
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Regional economic integration
Source: http://en.wikipedia.org/wiki/File:Economic_integration_stages_(World).png
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Trade creation and trade diversion
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Other effects of economic integration
Increase in competition (reducing monopoly power)» Lower prices (static efficiency)» Higher productivity/lower cost of production (dynamic efficiency)
Lower cost by expanding scales of production More opportunities for business investments (FDI)
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Case study: The European Union
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Trade embargoes
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International trade disputes
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GATT and WTO
GATT (1947)» General Agreement on Tariffs and Trade
WTO (1994)» World Trade Organization» www.wto.org
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism
Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade policy Free trade: Pros and cons
5. Foreign Exchange Markets and the Open Macroeconomy
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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First best vs. second best
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Costs of protection
Loss of welfare (deadweight losses) Foreign retaliation Enforcement costs Rent-seeking costs Rents to foreign producers (VERs) Dynamic inefficiencies (loss of dynamic efficiency)
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Externalities
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Promoting domestic production or employment
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The infant industry/dying industry arguments
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Public revenues
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Noneconomic objectives
„National pride“ National defense Domestic income redistribution
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Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open
Macroeconomy Foreign exchange markets and currency systems International financial investment Determination of exchange rate movements Open-economy macroeconomics
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
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Exchange rates (spot vs. forward rate)
Exchange rate» Price of one nation‘s money (e.g. USD) …» … in terms of another nation‘s money (e.g. EUR)
Euro area view: 0,73 [€/$] United States view: 1,37 [$/€]
Time dimension» Spot rate: price for immediate exchange» Forward rate: price set now for an exchange in the future
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Currency systems: Floating vs. fixed exchange-rate systems
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Appreciation/revaluation and depreciation/devaluation
Floating exchange rate» Appreciation» Depreciation
Fixed exchange rate» Revaluation» Devaluation
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Demand for and supply of foreign exchange
Demand-side» Imports of goods and services» Capital outflows
Supply-side» Exports of goods and services» Capital inflows
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Arbitrage
Exploiting price differentials» Between trading centers (NY, London, Frankfurt, Tokyo, …)» Between multiple currencies
• 1,6 [USD/GBP]• 0,9 [USD/CHF]• 0,5625 [GBP/CHF]
• 1,6 [USD/GBP] 1,0227 GBP• 0,9 [USD/CHF] 1,6363 USD• 0,55 [GBP/CHF] 1 GBP = 1,8181 CHF
KOOTHS | BiTS: International Economics (winter term 2014/2015) 121
Pegged exchange rates
KOOTHS | BiTS: International Economics (winter term 2014/2015) 122
Defending the peg: Official interventions
KOOTHS | BiTS: International Economics (winter term 2014/2015) 123
Exchange control
KOOTHS | BiTS: International Economics (winter term 2014/2015) 124
International experience: From the Gold Standard until today
KOOTHS | BiTS: International Economics (winter term 2014/2015) 125
Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open
Macroeconomy Foreign exchange markets and currency systems International financial investment Determination of exchange rate movements Open-economy macroeconomics
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
KOOTHS | BiTS: International Economics (winter term 2014/2015) 126
Exchange rate risk and speculation
KOOTHS | BiTS: International Economics (winter term 2014/2015) 127
Hedging and forward exchange contracts
KOOTHS | BiTS: International Economics (winter term 2014/2015) 128
Futures, Options, Swaps
KOOTHS | BiTS: International Economics (winter term 2014/2015) 129
The “Lake” model
KOOTHS | BiTS: International Economics (winter term 2014/2015) 130
Covered and uncovered transactions
KOOTHS | BiTS: International Economics (winter term 2014/2015) 131
Interest parity
Covered interest parity Uncovered interest parity
KOOTHS | BiTS: International Economics (winter term 2014/2015) 132
Outline
1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open
Macroeconomy Foreign exchange markets and currency systems International financial investment Determination of exchange rate movements Open-economy macroeconomics
6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt
KOOTHS | BiTS: International Economics (winter term 2014/2015) 133
Short run vs. long run analysis
Short-run» Asset market approach to exchange rates
(capital flows)
Long-run» Low of one price Purchasing power parity
(trade in goods and services)
KOOTHS | BiTS: International Economics (winter term 2014/2015) 134
Asset market approach and interest rate parity
KOOTHS | BiTS: International Economics (winter term 2014/2015) 135
Purchasing Power Parity (PPP)
KOOTHS | BiTS: International Economics (winter term 2014/2015) 136
Absolute vs. relative PPP
KOOTHS | BiTS: International Economics (winter term 2014/2015) 137
Monetary approach
KOOTHS | BiTS: International Economics (winter term 2014/2015) 138
Exchange rate overshooting
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