Core Macroeconomics, Hilary Term 2015

Week 5: The Open Economy

This week we open up our 3-equation Keynesian model to the outside world. Now demand depends not only on domestic consumption and investment, which react to the real interest rate, but also foreign demand for exports, which depends on the real exchange rate. The real exchange rate and the real interest rate are related through a foreign exchange market equilibrium condition: uncovered interest (rate) parity.

The open economy model is not easy, so this week we will focus on the technical aspects of how the model works. Next week we will consider the real world.

Readings

Lecture notes for lectures 8 and 9 by Rui Esteves.

C&S (new edition) chapters 9-10.
There are some differences between the new and old editions for this topic. Try to use the new. If you are using the older edition, you may find this working paper by Carlin & Soskice useful in bridging the gap.

Assignment

There is no essay this week. For the tutorial, you should be prepared to explain and use the open economy 3-equation model and answer questions on it. Have a look at the "checklist" questions at the end of the chapters in C&S as part of your preparation. I expect you to put as much effort into learning the open economy model as you would have put into writing an essay.