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1、2 February 2023,ROY DAHLSTEDT,1,INTRODUCTION TO INTERNATIONAL ECONOMICS ANDFINANCEROY DAHLSTEDT31 C 00400HKKK,2 February 2023,ROY DAHLSTEDT,2,Roy Dahlstedt Helsinki School of Economics Department of Economics Economicum building Arkadiankatu 7 2.floor,room A 220 Office hours for students:mo 10-12 Te
2、l.:43138498 E-mail:roy.dahlstedthkkk.fi,2 February 2023,ROY DAHLSTEDT,3,31C00400Introduction to International Economics and Finance 6 ects/4 crStatus of the course:B.Sc.(Econ),Economics program,optional courseObjectives:Understanding of international competitiveness in the modern world.Understanding
3、 of the fundamentals of competitiveness through the classical theories of international trade.Understanding of the basic determinants of international capital flows.Familiarity with international trade policy and monetary policy.Contents:In this course we study the international market as a combinat
4、ion of two parts-the commodity markets and the money&capital markets.In the commodity markets we are mainly interested in the problem of international competitiveness,its origins and measurement.We deal with the purchasing power parity exchange rates and real exchange rates but also with the fundame
5、ntals of competitiveness,input productivity,input prices and scale of production.In the capital markets we concentrate on capital allocation and international portfolio investments.The interest rate parity is essential in connecting international capital movements to exchange rates of currencies.A s
6、hort overview of the role of monetary policy in the context of EMU and the Euro is undertaken.Also,some examples of political tampering with free trade,trade policy,are analyzed.Literature:HUSTED,Steven&MELVIN,Michael:International Economics,6 th edition,Pearson Addison-Wesley Publishing 2004,isbn 0
7、-321-20461-1,or 7th edition,Pearson Addison-Wesley Publishing 2007,isbn 0-321-45122-8,chapters 1 20Lecturer:Dr.Sc.(Econ.)Roy DahlstedtEvaluation:Lectures and exercises 42 h,Dr.Sc.(Econ.)Roy DahlstedtExamTeaching:Fall 2007,first periodRegistration:Lectures and exam via WebOodiNote:Replaces the course
8、 31C031 Introduction to International Economics and Finance.If a student has already taken the course 31C031 and wishes to take the extended course 31C00400,they should contact the administrator at the Department of Economics.When they have completed the new course,credit for the course 31C031 will
9、be removed,and students will have 20 points added to their grade for the new course.Prerequisites:Principles of Economics Course website:the address to the course material will be announced at the first lecture,2 February 2023,ROY DAHLSTEDT,4,Exam opportunities:1.25.October,20072.26.November,20073.2
10、5.February,2008Pre-register for exam in WeboodiExam requirements:-textbook,as specified-lectures,with lecture materials-lecture handouts,2 February 2023,ROY DAHLSTEDT,5,Code:31 C 00400Lectures:42 h.6 ectsLiterature:Husted,Steven and Melvin,Michael:International Economics,6 th edition,Pearson Addison
11、 the Connection to Theories of International Trade 3.The International Trade of Capital and the Determination of Exchange Rates 3.1.International Financial Investments,Exchange Rate Risk and the Interest Rate Parity 3.2.The Exchange Rate,the Price Inflation Difference and the Interest Rate Differenc
12、e 3.3.The Global Equilibrium 4.Economic Policy Perspectives 4.1.The Economic and Monetary Union(EMU)4.2.Monetary Policy with Interest Rates and Exchange Rates,with Particular Reference to the European Central Bank 5.The Fundamentals of International Competitiveness:Productivity,Input Prices and Scal
13、e of Production 5.1.Differences in Productivity:the Absolute and Comparative Advantage 5.2.Differences in Input Prices 5.3.The Origin of Conflicts:the Effect of International Trade on Wages,Other Incomes and Employment within a Country 5.4.“Cost Effectiveness“through the Scale of Production 6.Exampl
14、es of the Usage of Trade Policy Measures:Tariffs,Subsidies and Tariff Unions 7.An Alternative Approach with a Simultaneous Treatment of the Capital and the Commodity Flows under Different Exchange Rate Regimes(Mundell-Fleming Framework),2 February 2023,ROY DAHLSTEDT,6,COURSE OUTLINE:International Go
15、ods and Services Markets International Trade in Goods and Services,Country A Country B,Price Price,registered in the Current Account of the Balance of Payments-explained with:a)The Pure Theory of International Trade Smith,Ricardo,based on:input productivity Heckscher&Ohlin,based on:input prices b)Th
16、e“New“Theories Krugman,based on:scale economies c)The Purchasing Power Parity Theory Cassel,based on:inflation+nominal exchange rate in country A in country B,International Capital and Money MarketsInternational Trade in Financial Capital,Nominal exchange rate,Interest rate Interest ratein country A
17、 in country B,a)The Interest Rate Parity Theoryb)The Monetary Theories-registered in the Capital Account of the Balance of Payments-explained with:,The Fisher Equations Global Equilibrium of the allocation of goods,services and capital,combining prices andinterest rates,Trade policyMonetary policy,A
18、lternative approaches:open economy macroeconomics,Average costof production,Real exchange rate,Inflation,Nominal exchange rate,Country A Country B a)or b),1.,2 February 2023,ROY DAHLSTEDT,7,Purchasing Power Parity Theorem:(Gustav Cassel 1922),The same price for the same product in two countries and
19、in two different currencies;the exchange rate which realizes this is the PPP rate for this product:micro levelLaw of One Price(LOP)The same price levels(indices)in two countriesin two different currencies;the exchange ratewhich realizes this is the PPP rate for thesecountries currencies:macro levelu
20、se same price indices with same base years Purchasing Power Parity(PPP)Theorem;Absolute Version:the ratio of prices or price levels at a point of time Relative Version:the change in the ratio of prices or price levels during a period of time,2.The Concept,the Origins and the Measurement of Internati
21、onal Competitiveness in the Commodity Markets,2.1.The Purchasing Power Parity under Fixed and Floating Exchange Rate Regimes,2 February 2023,ROY DAHLSTEDT,8,Example:Absolute parity Product/basket A,price in England:GBP 2Product/basket A,price in USA:USD 4Exchange rate USD/GBP:2.20/1buy from USA,pay
22、USD 4/unitexport to England,you get GBP 2/unitExchange GBP 2 x 2.20=USD 4.40/unitProfit USD 0.40/unitthere will be a net export(in the current account)from USAto England,i.e.a current account deficit in England Assume a fixed exchange rate regime:Economic policy measures together with demand/supp.GB
23、P 2.0 x 2.20=4.40 USD(1.8)(4.00),2 February 2023,ROY DAHLSTEDT,9,Example:Initial situation as above Assume a floating exchange rate regime:The demand for the USD strengthens and the supplyof the GBP strengthens;the dollar appreciates and the pound depreciates.The time period is shorter than above an
24、d the current account effects are small.USD/GBP 2.20/1.2.0/1=2 2.20/1.1=2(an alternative expression for the change in the exchange rate),2 February 2023,ROY DAHLSTEDT,10,CURRENT TOPICS AND DATA PAGES WILL BE HANDED OUT AT LECTURES,2 February 2023,ROY DAHLSTEDT,11,Example:Relative parity A SEK 5/USD
25、1 ABasket BasketSEK 100 PPP abs.USD 20inflation inflation10%5%SEK 110 SEK 5/USD 1 USD 21 PPP abs.no(USD 22)(SEK 105)trade Relative purchasing power parity:the required change in the nominal rate which exactly compensates for the effect of the difference in the rates of inflation;when this is true th
26、e initial parity situation will also hold in the next point of time(here new absolute PPP-rate:5.24/1),Point of timet0,Point of timet1,2 February 2023,ROY DAHLSTEDT,12,The macro concept(PPP)Gross national product of SwedenSEK(=product basket)PPP exchange rate sets thevalue of the Danish GNPequal to
27、the value of theSwedish GNP;if the price levelin Denmark rises(inflation)the nominal exhange rate changes correspondingly Gross national product of Denmark DKR(=product basket)Measurement problem:Theoretically,the contents of the two baskets,that is,the structure of GNPs,should be alike.The macro pu
28、rchasing power parity is valid for the price levels but not necessarily for individual prices.,2 February 2023,ROY DAHLSTEDT,13,A visualizing and approximative presentation of the relationships between the inflation differential,the PPP-exchange rate,the actual nominal exchange rate,and the real exc
29、hange rate.It has been demonstrated that the PPP-exchange rate is the one nominalrate which continuously exactly compensates for the inflation differential,that is,the change in the nominal exchange rate which corresponds to the change in the ratio ofthe price levels.,t0 t1,exchange rateas an index
30、number;t0=100and this is assum.to be PPP-rate,Assume the inflation situation in example 1.3.above but assume that the SEK is devalued by 1%to 5.05/1 from t0 to t1.,100(5/1)(=PPP),Requirement:Approximation:I(SEK)-I(USD)This is the inflation differential;this should be compensated by a corresponding c
31、hange of 5%in the exchange rate giving us 110/21=5.24 as the new PPP-rate.,PPP 105(5.24),Nominal101(5.05),Real96(4.8),Gap,-This change in purchasing power is a gap of undercompensation of required devaluation-defined as:real term revaluation measured by the real exchange rate-Gap of overcompensation
32、 of req.devaluation-real term devaluation-Analogously for a required revaluation,This is the actual change in theexchange rate,1%,so now therate is not PPP.,Now,higher Swedish inflation(higher prices)is not completelycompensated by giving moreSEKs in exchange for the othercurrency(USD);the purchasin
33、gpower of the other currency(USD)on the Swedish market is diminished.,A change in purchasing power!,2.2.The Real Exchange Rate as a Quantitative Measure of International Competitiveness,2 February 2023,ROY DAHLSTEDT,14,The real exchange rate measures international competitiveness:Diminishing purchas
34、ing power of the foreign currency gap of undercompensation of required devaluation real exchange rate revaluation loss of international competitiveness of the domestic market(Swedish).Increasing purchasing power of the foreign currency gap of overcompensation of required devaluation real exchange ra
35、te devaluation improvement in international competitiveness of the domestic market(Swedish).And analogously for gaps of required revaluation(required devaluation/positive inflation differential is always mirrored by a required revaluation/negative inflation differential for the foreign currency)Comp
36、are and distinguish:nominal revaluation loss of competitiveness nominal devaluation improvement in competitiveness but for different reasons:nominal rate determines how much of one currency you get against the other currency(amount of money,irrespective of inflations)whereas real rate determines how
37、 much you can buy with that currency(purchasing power of that money),2 February 2023,ROY DAHLSTEDT,15,So what happened when both the nominal and real exchange rates changed?The initial situation was:One SEK-basket buys one USD-basket;this purchasing power parity is realized by a nominal exchange rat
38、e of 5/1 becausethen 100 SEK/5=20 USDAfter inflations and the devaluation of SEK by 1%:A)One SEK-basket brings SEK 110/5.05=USD 21.8 which is 1.03 USD-baskets/purchasing power of SEK is increased/purchasing power of USD decreased/competitiveness of US increased/competitiveness of Sweden decreased/SE
39、K appreciated real termUSD depreciated real termB)One USD-basket brings USD 21*5.05=SEK 106.05 which is 0.96 SEK-baskets/purchasing power of USD decreased/purchasing power of SEK increased/competitiveness of Sweden decreased/competitiveness of US increased/USD depreciated real term SEK appreciated r
40、eal term Remember:if you do not start from a PPP-exchange rate,a parity situation,even if the change in the nominal exchange rate exactly corresponds to the inflation differential(and there is,in this case,no change in the purchasing power),you do not end up with a PPP-rate,a parity situation;you ne
41、ed a change in the nominal rate which is either larger or smaller than the inflation differential(and,therefore,a change in the purchasing power)to end up with a PPP-rate,a parity situation.,2 February 2023,ROY DAHLSTEDT,16,CURRENT TOPICS AND DATA PAGES WILL BE HANDED OUT AT LECTURES,2 February 2023
42、,ROY DAHLSTEDT,17,COMPETITIVE RISK AND EXPOSURE manifested in the changes of the real exchange rate!,Domestic enterpriseA,Competitor with imported inputB,Swiss market,Component Imported component SEK 100 price SEK 100 price SEK/CHF CHF 10 price 10/1 exchange rate,Component Imported component SEK 110
43、 SEK 105 SEK/CHF CHF 10,5 10/1,10%inflation,5%inflation,Component Imported component SEK/CHF CHF 10,5 SEK 110 SEK 107,1 10.2/1,SEK depreciates 2%,I,II,III,Make sure that you can correctly answer the following questions!What is the change in the real exchange rate from phase I to phase II?What is the
44、 change in the real exchange rate from phase II to phase III?What should have been the change in the nominal rate so as not to let the real rate change?What is the transaction risk caused by the change in the nominal rate?What is the change in the competitive situation of a domestic firm with no for
45、ex transactions and no risks caused bythe changes in the nominal exchange rate?,2 February 2023,ROY DAHLSTEDT,18,Formal(mathematical)treatment ofPurchasing Power Paritydenote:,price levelinflation rateprice level indexpurchasing power parity exchange rate at point of time t0,FIM/USD absolute parityp
46、urchasing power parity exchange rate at point of time t1,FIM/USD absolute parity,Definition:Absolute parity,Definition:Relative parity,2 February 2023,ROY DAHLSTEDT,19,Divide both sides with S,reorganise terms:Version 1:The percentage change of the exchange rate compatible with the relative inflatio
47、n differential;the required change to ensure purchasing power parity,Version 2:,Examples:we have the following data price of basket exchange rate inflation rate price level index FIM USD FIM/USD FIM USD FIM USDt0 100 20 5/1 nominal,parity 0.10 0.05 100 100t1 110 21 5.238/1 parity*)110 105 5.05/1 nom
48、inal 4.821/1 real*),*)Absolute parity at t15.238=110/21 by definition5.238=5/1*1.10/1.05 by version 25.238=5/1*110/105 by version 2 using indeces(5.238-5.00)/5.00=(0.10-0.05)/1.05=0.0476 4.76%required change of exchange r.depreciation of FIM,Calculating the new absolute parity exchange rate on the b
49、asis of theoriginal and the relative inflation differential as a correction coefficient,2 February 2023,ROY DAHLSTEDT,20,*)Real exchange rate at t1:a measure of the purchasing power of one USD on the Finnish market,diminished by the inflation differential not covered by the change in the nominal exc
50、hange rate:relative inflation differential:0.0476 4.76%change in the nominal exchange rate(5.05-5.00)/5.00=0.01 1%,depreciation of AIM,4.821=5.00*(5.05/5.238),Note!S nom t1refers to the actualnominal exchange rateat time t1;it is not necessarily nor probablythe PPP-exchange rate attime t1,which is S
