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The Evolution of a Regional Economy

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  • 1. New Notation Introduction Steady State Solutions in REG Experiments with REG EC6012 Lecture 8 The Open Economy Stephen Kinsella Dept. Economics, University of Limerick March 11, 2008 Stephen Kinsella EC6012 Lecture 8
  • 2. New Notation Introduction Steady State Solutions in REG Experiments with REG Objectives today 1 New Notation 2 Introduction 3 Steady State Solutions in REG 4 Experiments with REG Increasing µS Increasing GTS Increasing (1 − µS ) Changing Liquidity Preferences Stephen Kinsella EC6012 Lecture 8
  • 3. New Notation Introduction Steady State Solutions in REG Experiments with REG New Notation All the notation you’re no doubt familiar with (C , G , Y ), etc is still in use, but for space and sanity, I’m only including the newer variables and parameters to be used in this model. Symbol Meaning N, S North and South Holdings, respectively. µ Propen X Exports IM Imports GTN Total Government expenditures injected in a period. Stephen Kinsella EC6012 Lecture 8
  • 4. New Notation Introduction Steady State Solutions in REG Experiments with REG Introduction PC and PCEX are extended here to show the interactions and feedbacks from a two region economy with trade. We partition PC into a North (N) and a South (S) and allow imports and exports to and from these regions. Stephen Kinsella EC6012 Lecture 8
  • 5. New Notation Introduction Steady State Solutions in REG Experiments with REG Balance Sheet Matrix for REG Introducing the Open Economy 171 Table 6.1 Balance sheet of two-region economy (Model REG) North South Central households households Government bank Cash money N +Hh S +Hh −H 0 Bills +BN h +BS h −B +Bcb 0 Wealth (balancing item) N −Vh S −Vh −Vg 0 0 0 0 0 0 0 temic approach, methodologically identical with the closed economy models Figure: Balance Sheet Matrix for REG already presented.2 Our open-economy models will evolve organically in stages from model PC in Chapter 4. We start off with the very same (closed) economy described by model PC, and then imagine how the economies of two component regions, which together make up the total, interact with one another and with the government. This will be Model REG. In subsequent sections we deal with a two-country system, each with its own currency. This will be Model OPEN. 6.2 The matrices of a two-region economy Stephen Kinsella EC6012 Lecture 8
  • 6. New Notation Introduction Steady State Solutions in REG Experiments with REG National Income Equations YN = C N + G N + X N − IM N , (1) N N N IM = µ ·Y , (2) N S X = IM . (3) (4) Stephen Kinsella EC6012 Lecture 8
  • 7. New Notation Introduction Steady State Solutions in REG Experiments with REG Other Key Equations The next equations describe the evolution of regional disposable income, taxes, wealth, consumption, money demand and bills (we call them bonds) demand functions. YD N = Y N − T N + r−1 · Bh−1 N (5) TN = θ · (Y N + r−1 · Bh−1 ) N 0<θ<1 (6) N V = V−1 + (YD N − C N ) N (7) N C = N N α1 · YD N + α2 · V−1 N 0 < α1 < α2 < 1 (8) N Hh = V N − BhN (9) N Bh YD N = λN + λ N · r − λN · 0 1 2 (10) VN VN Stephen Kinsella EC6012 Lecture 8
  • 8. New Notation Introduction Steady State Solutions in REG Experiments with REG Other Key Equations The next equations describe the evolution of regional disposable income, taxes, wealth, consumption, money demand and bills (we call them bonds) demand functions. YD N = Y N − T N + r−1 · Bh−1 N (5) TN = θ · (Y N + r−1 · Bh−1 ) N 0<θ<1 (6) N V = V−1 + (YD N − C N ) N (7) N C = N N α1 · YD N + α2 · V−1 N 0 < α1 < α2 < 1 (8) N Hh = V N − BhN (9) N Bh YD N = λN + λ N · r − λN · 0 1 2 (10) VN VN Stephen Kinsella EC6012 Lecture 8
  • 9. New Notation Introduction Steady State Solutions in REG Experiments with REG Other Key Equations The next equations describe the evolution of regional disposable income, taxes, wealth, consumption, money demand and bills (we call them bonds) demand functions. YD N = Y N − T N + r−1 · Bh−1 N (5) TN = θ · (Y N + r−1 · Bh−1 ) N 0<θ<1 (6) N V = V−1 + (YD N − C N ) N (7) N C = N N α1 · YD N + α2 · V−1 N 0 < α1 < α2 < 1 (8) N Hh = V N − BhN (9) N Bh YD N = λN + λ N · r − λN · 0 1 2 (10) VN VN Stephen Kinsella EC6012 Lecture 8
  • 10. New Notation Introduction Steady State Solutions in REG Experiments with REG Other Key Equations The next equations describe the evolution of regional disposable income, taxes, wealth, consumption, money demand and bills (we call them bonds) demand functions. YD N = Y N − T N + r−1 · Bh−1 N (5) TN = θ · (Y N + r−1 · Bh−1 ) N 0<θ<1 (6) N V = V−1 + (YD N − C N ) N (7) N C = N N α1 · YD N + α2 · V−1 N 0 < α1 < α2 < 1 (8) N Hh = V N − BhN (9) N Bh YD N = λN + λ N · r − λN · 0 1 2 (10) VN VN Stephen Kinsella EC6012 Lecture 8
  • 11. New Notation Introduction Steady State Solutions in REG Experiments with REG Other Key Equations The next equations describe the evolution of regional disposable income, taxes, wealth, consumption, money demand and bills (we call them bonds) demand functions. YD N = Y N − T N + r−1 · Bh−1 N (5) TN = θ · (Y N + r−1 · Bh−1 ) N 0<θ<1 (6) N V = V−1 + (YD N − C N ) N (7) N C = N N α1 · YD N + α2 · V−1 N 0 < α1 < α2 < 1 (8) N Hh = V N − BhN (9) N Bh YD N = λN + λ N · r − λN · 0 1 2 (10) VN VN Stephen Kinsella EC6012 Lecture 8
  • 12. New Notation Introduction Steady State Solutions in REG Experiments with REG Other Key Equations The next equations describe the evolution of regional disposable income, taxes, wealth, consumption, money demand and bills (we call them bonds) demand functions. YD N = Y N − T N + r−1 · Bh−1 N (5) TN = θ · (Y N + r−1 · Bh−1 ) N 0<θ<1 (6) N V = V−1 + (YD N − C N ) N (7) N C = N N α1 · YD N + α2 · V−1 N 0 < α1 < α2 < 1 (8) N Hh = V N − BhN (9) N Bh YD N = λN + λ N · r − λN · 0 1 2 (10) VN VN Stephen Kinsella EC6012 Lecture 8
  • 13. New Notation Introduction Steady State Solutions in REG Experiments with REG Steady State Solutions A region reaches their steady state when the change in household wealth from period to period is zero, so ∆V = 0. The condition where this holds is GT + X N = T N + IM N N (11) In the stationary state, GDP in the North will depend on the following condition: GT + X N N Y N∗ = (12) θ + µN Stephen Kinsella EC6012 Lecture 8
  • 14. New Notation Introduction Steady State Solutions in REG Experiments with REG Harrod’s Foreign Trade Multiplier Discussion Equation 12 shows the Harrod foreign trade multiplier, which shows how the North’s output is dependent on the North’s government expenditure and their exports, divided by the tax and import propensities. What does this imply for policies to get the economy to the steady state? Stephen Kinsella EC6012 Lecture 8
  • 15. New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) Experiments with REG Changing Liquidity Preferences Experiments: Evolution of Balances North and South Introducing the Open Economy 181 North region GDP 109.5 108.0 106.5 105.0 103.5 South region GDP 102.0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Figure 6.1 Evolution of GDP in the North and the South regions, following an increase in the propensity to import of the South region Figure: Evolution of Balances North and South The evolution of output in each region, as described in the preceding Stephen Kinsella EC6012 Lecture 8
  • 16. New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) Experiments with REG Changing Liquidity Preferences Evolution of GDP in North-South Regions following an increase in µS 182 Monetary Economics 0.00 Change in household wealth of the South region –0.25 –0.50 Government balance with the South region –0.75 –1.00 Trade balance of the South region –1.25 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 Figure 6.2 Evolution of the balances of the South region – net acquisition of financial Figure:assets by the household sector, in North-South Regions following an increase Evolution of GDP government budget balance, trade balance – following in µS an increase in the propensity to import of the South region which exists between two parts of a single country which has a unitary fiscal Stephen Kinsella EC6012 Lecture 8
  • 17. New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) Experiments with REG Changing Liquidity Preferences S Increasing GT 184 128.0 124.0 South region GDP 120.0 116.0 North region GDP 112.0 108.0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Figure 6.3 Evolution of GDP in the South and the North regions, following an increase Figure: Evolution of GDP in North-South Regions following an increase in the government expenditures in the South region S in GT 2.0 Stephen Kinsella EC6012 Lecture 8
  • 18. 108.0 New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Experiments with REG Changing Liquidity Preferences S Figure 6.3 Evolution of GDP in the South and the North regions, following an increase Evolution of Balances following an increase in GT in the government expenditures in the South region 2.0 1.0 Change in household wealth of the South region 0.0 –1.0 Trade balance of the South region –2.0 Government balance with the South region –3.0 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 Figure 6.4 Evolution of the balances of the South region – net acquisition of financial assets by the household sector, government budget balance, trade balance – following S Figure: Evolution of Balances following an increase in GT an increase in the government expenditures in the South region Stephen Kinsella EC6012 Lecture 8
  • 19. New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) Experiments with REG Changing Liquidity Preferences Evolution of GDP following an increase in Southern Propensities to Save Introducing the Open Economy 185 107.50 106.25 North region GDP 105.00 103.75 South region GDP 102.50 101.25 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Figure 6.5 Evolution of GDP in the North and South regions, following an increase Figure: Evolution of GDP following an increase in Southern Propensities in the propensity to save of South region households to Save to a higher steady-state level of output. What happensLecture 8our two-region Stephen Kinsella EC6012 now in
  • 20. New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) Experiments with REG Changing Liquidity Preferences Evolution of Balances following an increase in µS Introducing the Open Economy 185 107.50 106.25 North region GDP 105.00 103.75 South region GDP 102.50 101.25 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Figure 6.5 Evolution of GDP in the North and South regions, following an increase Figure: Evolution of Balances following an increase in µS in the propensity to save of South region households to a higher steady-state level of output. What happens now in our two-region economy if the households in one region decide to increase their propensity Stephen Kinsella EC6012 Lecture 8
  • 21. New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) Experiments with REG Changing Liquidity Preferences Evolution of Balances following a change in Southern liquidity preferences. Introducing the Open Economy 187 0.120 0.080 Increase in household wealth of the South region 0.040 0.000 Trade deficit of the South region –0.040 Government deficit with the South region –0.080 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 Figure 6.7 Evolution of the balances of the South region – net acquisition of financial assets by the household sector, government budget balance, trade balance – following Figure: Evolution of Balances following a change in Southern liquidity a decrease in the liquidity preference of South region households preferences. in liquidity preference by Southern households has some positive economic repercussions on the South, as it now benefits from higher total government expenditures. But all these effects are of a second-order magnitude. Stephen Kinsella EC6012 Lecture 8
  • 22. New Notation Increasing µS S Introduction Increasing GT Steady State Solutions in REG Increasing (1 − µS ) Experiments with REG Changing Liquidity Preferences Next Time The Open Economy. Read GL, pages 187–211. Stephen Kinsella EC6012 Lecture 8