Stephanie Schmitt-Groh´e2 3 First draft, Fall 1998

1 International Macroeconomics1 Stephanie Schmitt-Groh e2 Mart n Uribe3 First draft , fall 1998 Last updated: June 25, 20141 The seeds for this manuscript were lecture notes taken by Alberto Ramos ina course on International Finance that Mike Woodford taughtat the University ofChicago in the Winter of University. E-mail: University. E-mail: Global Balance-of-Payments Accounting .. The Current Account .. The Current Account and the Net International InvestmentPosition .. Valuation Changes and the Net International InvestmentPo-sition .. The Negative-NIIP-Positive-NII Paradox: Dark Matter?.. Dark Matter .. Return Differentials .. Who Lends and Who Borrows Around the World? .. Exercises .. 322 Current Account Can a Country Run a Perpetual Trade Balance Deficit?

2 Can a Country Run a Perpetual Current Account Deficit? . Savings, Investment, and the Current Account .. Current Account Deficits As Declines in the Net In-ternational Investment Position .. Current Account Deficits As Reflections of Trade Deficits The Current Account As The Gap Between Savingsand Investment .. The Current Account As the Gap Between NationalIncome and Domestic Absorption .. Four Ways of Viewing the Current Account .. Appendix: Perpetual Trade-Balance and Current-AccountDeficits in Infinite-Horizon Economies .. Exercises .. 543 A Theory of Current Account A Small Open Economy .. Equilibrium .. Temporary Versus Permanent Output Shocks .. Temporary Output Shocks .. Permanent Output Shocks.

3 Terms-of-Trade Shocks .. World Interest Rate Shocks .. An Economy with Logarithmic Preferences .. Capital Controls .. Exercises .. 854 Uncertainty and the Current The Great Moderation .. The Great Moderation And The Emergence of TradeImbalances .. A Model With Uncertainty .. The Return of Uncertainty: The Great Contraction And TheCurrent Account .. Exercises .. 1015 Current Account Determination in a Production A production economy .. Firms .. Households .. Equilibrium in a closed economy .. Equilibrium in an open economy .. Current account adjustment to output and world-interest-rateshocks .. A temporary output shock .. A world-interest-rate shock .. Exercises .. 1286 External Adjustment in Small and Large The Current Account Schedule.

4 External Adjustment in a Small Open Economy .. Interest Rate Shocks .. Temporary Output Shock .. An investment surge .. Country Risk Premia .. External Adjustment in a Large Open Economy .. The Global Saving Glut Hypothesis .. The Period 1996 to 2006 .. The Period 2006 to 2012 .. Optimal Capital Controls in a Two-Country Model .. Market Clearing in World Capital Markets .. Equilibrium Under Free Capital Mobility .. Equilibrium when countryCimposes capital controls Exercises .. 1677 Twin Deficits: Fiscal Deficits and Current Account Twin Deficits in the United States .. Testable Implications of the Twin Deficit Hypothesis .. The government sector in the open economy .. Ricardian Equivalence .. Then what was it?

5 Government Spending and Current Account Deficits .. Failure of Ricardian Equivalence .. Borrowing Constraints .. Intergenerational Effects .. Distortionary Taxation .. Exercises .. 1998 International Capital Market Measuring the degree of capital mobility: (I) Saving-Investmentcorrelations .. Measuring capital mobility: (II) Interest rate differentials .. Covered interest rate parity .. Real interest rate differentials and capital market in-tegration .. Exchange Risk Premium (f se) .. Expected Real Depreciation,se s+ e e.. Uncovered Interest Rate Parity .. Asset Pricing in a 2-Period Small Open Economy .. The Forward Premium Puzzle .. Carry Trade .. Exercises .. 2429 Determinants of the Real Exchange The Law of One Price.

6 Purchasing Power Parity .. Deviations from PPP due to Nontradables .. Productivity Differentials and Real Exchange Rates: TheBalassa-Samuelson Model .. Application: The Real Exchange Rate and Labor Pro-ductivity: 1970-1993 .. Application: Deviations from PPP observed betweenrich and poor countries .. Trade Barriers and Real Exchange Rates .. Exercises .. 27110 Changes in Aggregate Spending and the Real The production possibility frontier .. The income expansion path .. Partial equilibrium .. General equilibrium .. Wealth shocks and the real exchange rate .. World interest rate shocks .. Terms-of-trade shocks .. Exercises .. 30711 The Macroeconomics of External The debt crisis of developing countries of the 1980s.

7 The resurgence of capital inflows to developing countries inthe 1990s .. The Debt Burden .. Debt Reduction Schemes .. Unilateral Debt Forgiveness .. Debt Overhang .. The Free Rider Problem In Debt Forgiveness .. Third-party debt buy-backs .. Debt swaps .. Exercises .. 337 CONTENTSix12 Monetary Policy and Nominal Exchange Rate The quantity theory of money .. AFloating (or Flexible) Exchange Rate Regime .. Fixed Exchange Rate Regime .. Fiscal deficits, inflation, and the exchange rate .. The Demand For Money .. Purchasing power parity (PPP) .. The interest parity condition .. The government budget constraint .. A fixed exchange rate regime .. Fiscal deficits and the sustainability of currency pegs . A constant-money-growth-rate regime.

8 The Inflation Tax .. The Inflation Tax Laffer Curve .. Inflationary finance .. Money growth and inflation in a growing economy .. Balance-of-payments crises .. Appendix: A dynamic optimizing model of the demand formoney .. 374xCONTENTSC hapter 1 Global Balance-of-Payments AccountingA country s international transactions are recorded in thebalance-of-paymentsaccounts. In the United States, the balance-of-payments accounts are com-piled by the Bureau of Economic Analysis (BEA), which belongs to Department of Commerce. Up-to-date balance of payments data canbe found on the BEA s website country s balance of payments has two main components: thecurrentaccount and the financial account. The current account records exportsand imports of goods and services and international receipts or paymentsof income.

9 Exports and income receipts enter with a plus and imports andincome payments enter with a minus. For example, if a resident buysa smartphone from South Korea for $500, then the currentaccountgoes down by $500. This is because this transaction represents an importof goods worth $ Schmitt-Groh e and M. UribeThe financial account keeps record of sales of assets to foreigners andpurchases of assets located abroad. Thus, the financial account measureschanges in a country s net foreign asset position. Sales of assets to foreignersare given a positive sign and purchases of assets located abroad a negativesign. For example, in the case of the import of the smartphone, if the pays with currency, then a South Korean resident (Samsung) isbuying assets (currency) for $500, so the financialaccount receivesa positive entry of $ smartphone example illustrates a fundamental principle of balance-of-payments accounting known asdouble-entry bookkeeping.

10 Each transac-tion enters the balance of payments twice, once with a positive sign and oncewith a negative sign. To illustrate this principle with another example, sup-pose that an Italian friend of yours comes to visit you in New York and staysat the Lucerne Hotel. He pays $400 for his lodging with his Italian VISA card. In this case, the is exporting a service (hotel accommodation),so the current account increases by $400. At the same time, the LucerneHotel purchases a financial asset worth $400 (the promise of VISA-Italy to1 There is a third component of the Balance of Payments called the capital component is quantitatively insignificant in the United States, so we will ignore keeps record of international transfers of financial capital. The major types of entries inthe capital account are debt forgiveness and migrants transfers (goods and financial assetsaccompanying migrants as they leave or enter the country).)