Econometrics!

Of

“International Business”
Open Economy:- This is a type of an Economy in which Economic
activities i.e. Trading, Activity & Exchange of Goods, Services
amongst People between domestic and International Community
Total expenditure of a country (Y)= (C+I+G+NX); X(Exports),
V(Imports); Here, C=Consumption of Consumer , I= Injection of
Money into the Country by The Firms, G= Government Investment /
Spending, NX= Net Exports (Exports- Imports).
Income Levels (Domestic & Foreign Per Capita Income as a comparison)
Prices, Relative Prices of Goods & Services (Domestic Prices & Foreign
Prices)
Exchange Rates $D(Domestic Currency) $F(Foreign Currency); E.g.
In normal How much Domestic currency is Equal to 1 US Dollar
which may Appreciate/ Increases or Depreciate/ Decreases!
Henceforth, Whenever Exchange Rates (e) increases, $Domestic
Currency depreciates, Exports (X) Increases, Imports (V) Falls, the Net
Exports (X-V) Increases, also, the Total Expenditure (Y), Increases, IS
may shift to the Right. At the same time, whenever, any of the other
factor from the Equation Y= C+I+G+NX(X-V); C (How Consumer’s
Spend?), I (Injection of Money by the Firms), G (Governmental
Investment/ Expenditure in the Country), finally, the NX (Exports –
Imports)
The Fiscal Policy relates here as the Governmental expenditure, Tax
cuts in the Economy increases. In the Expansionary Fiscal policy, the
spending, cut Taxes by the Government increases, Vice- Versa, the
Governmental spending may decrease calling it a the “Contractionary
Fiscal Policy”. IS may shift Right or Left!
If, the Exchange rates (e) increases => X (Exports Increase), i.e. the
exporters get more currency earnings to Export the items and earn in
foreign exchange.
Imports are the expenditure on the foreign goods instead of domestic
goods. A high domestic income has an impactful higher Domestic
and Foreign goods and services consumption. Hence, An increase in
the income levels causes the imports to rise. Also, the Relative Prices
of the goods and services describes the impactful consumption and
choices
As explained earlier, the increase in the exchange rates (e) causes the
decrease in the imports as well. As, an increased (e) relates to decrease
of imports as the relative price of foreign goods become more
expensive.
Similarly we see that either; Decrease in the National Income (Y) also
causes likewise the exchange rates (e) the Imports (V) to fall.
The IS Curve:- In an open economy, trade in Goods and Services, this Curve
is to be determined at the exchange rates (e). The IS shows the relationship
between the (Y) National Income and the (i) Interest rates for many
combinations of the Total expenditures, Level of production, the Total
Expenditures are also determined by the Exchange rates (e), since they affect
the level of Net Exports (NX). The IS curve is dependent on the Exchange
Rate regimes i.e. in the fixed rate; the curve if fixed (unless the government
spending, taxes, devalues or revalues the currency); floating rate regime (i.e
the exchange rates increases or decreases for the demand and Supply of the
Foreign Exchange). So! whenever the Exchange rates (e) increases,
$Domestic Currency decreases, Exports increase, Total Expenditure have
risen, IS curve Shifts to the “RIGHT”.
Y IS Shifts to Right or Left due to Fiscal Expansion or Contraction
(Governmental Taxation Policy)
•Taxation is charged more for the
(i) National Income (Output) to Increase

Explanation for the

Curve :- In the stated
Figure; As the Interest
rate ‘i ‘on (Y- Axis)
increases & Country is
having an Output ‘Y’
ON (X-Axis), the
Investments and
Savings decreases,
due to increase in the
added Prices of the
Goods & Services in
the Economy!

O (Y) X
The LM Curve (Liquidity Preference and Money Supply curve):- The
National Income and the Country interest rates has the combinations for an
achievement of the Money Market Equilibrium, i.e. Money Demand is
equal to Money Supply. This curve is Upward sloping, if/when the per-
capita income increases, there is a higher Money Demand leading to higher
interest rates (i) thus a corresponding Income (Y) increases as in when
achieving Equilibrium.

The LM curve is simply a function, representing an equation:-

LM= Money Supply Although, the Central Banks
Price (Federal Banks/ Reserve Bank of India) decide to
increase/decrease Money supply i.e. if they buy/sell Treasury Bills (T. Bills;
for e.g. Treasury Bills, notes, bonds) to increase/decrease the Money Supply.
The R.B.I. (Reserve Bank of India) buys or sells the Foreign Currency for
Indian Rupees to regulate Liquidity also called Sterilization (withdrawal of
excess liquidity in the Macro-Econometrics.
The Monetary Policy correlates to the LM Curve, the money supply
causes a shift in the LM curve; expansion in Money Supply shifts it to
the Right, the decrease in the Money Supply shifts it to the Left.
In case, if the Economy is in Recession (by lowering the Interest rates
at the same time increasing the Demand for Investments), the
Government (with the Federal Bank/ Reserve Bank) adopts measure
for the increase in the Money Supply i.e. “Expansionary Monetary
Policy” as per enlisting above.
Similarly, in the case of Inflation, the Government along the Central
or Federal Bank of the country, sells the Bonds or Governmental
Securities in the Open Market or the Central Banks raise higher Cash
Reserve Ratio with the Banks , eventually reducing the money in the
Economy causing a LM curve to move left, known as the
“Contractionary Monetary Policy”!!
 LM 1
LM 2

Effect of the
Expansion
R1
of Money
R2
Supply,
Interest Rate
& Income.
Y1 Y2

Expansionary Monetary Policy

 LM 1
LM 0

R1

R2

Y1 Y0

Contractionary Monetary Policy (Fight Inflation)

BOP curves are dependent on the Current Account (CA), Capital Account (KA), Financial
Accounts (FA) of the country in trade of goods & services, Capital flows i.e. Financial
Instrumentalization i.e. Banks, Finance Capitalists for the acquiring; Loans, Mortgage,
Insurances for Business/ Private Assets in the Economy. i.e. the equation shall be
BOP(Balance of Payment)= CA(Current Account)+KA(Capital
Account)+FA(Financial Account
The Current Accounts (CA) represents the net exports of a country and domestic level of
income, which affects the Imports (V) & Exports (X). If, the domestic per-capita income rises,
Imports (V) rises Exports (X) stay constant, thus, as the income rises, exchange rates (e) remain
constant, NX falls, also the CA Falls i.e. (CA=Exports(X)- Imports(V))

The Capital Account (KA) is the Capital Flows (Financial Capital Flows) of the country,
assuming the interest rates (i) on that capital, as the rise or increase in the domestic interest
rates (i-d) causes the rise of the Capital K-inflows; As, with the increase in the (i-d), causes the
Multinational Companies/ investees to increase the investments leading to high profit..! Also
vice-versa, the fall in the domestic interest rates will attract the capital moving to foreign
countries/ other Countries, Capital Outflows happen! i.e. (KA= Capital Inflows- Capital
Outflows)
Financial Account (FA):- The Financial accounts are the components of the
Balance of Payments that proves claims or liabilities to the Non-Residents,
which may be the Direct Investment, Portfolio Investment and Reserve Assets
of the Non-Residents.
Henceforth, BOP(Balance of Payment)= CA(Current Account)+KA(Capital
Account)+FA(Financial Account).

There are three conditions of the BOP Curves:-(1) Perfectly Mobile (perfectly
horizontal):- Here, the change in the Interest Rates (i), causes a lot of KA-
capital flows. If, the Interest-Rate-Domestic (i-d) is higher, then Interest-Rate-
Foreign (i-f) excessive capital inflows happen, and visa-versa, as Capital inflow
is defined as the finance required to buy Goods or Products in the market, i.e.
Loans, Mortgage and Insurances etc.), the Foreign Companies are more
profitably interested to move to India. Also, the specific exchange rate (e)
regimes shall define the central banks to buy or sell the domestic currency to
counteract currency levels and retain the Balance.
 Under Fixed rate regime: The
BP curve does not shift,
regardless of the degree of
capital mobility. The Central
Bank must increase or decrease
the money supply to counter
any surplus or deficit in the
Balance of Payments.

Under Flexible rate regime; Perfectly mobile capital flows: The BP does not shift
(Capital flows overwhelm the change in the Current Account). The change in the
exchange rate affects Net Exports and therefore the IS curve.
Mobile capital flows: The change in the exchange rate affects NX, and therefore
the Current Account. The IS and the BP both shift (in the same direction).
Perfectly Immobile capital flows: same as for mobile, is more steeper than it.
Perfectly Mobile Capital Flows: - The BOP Curve is a Horizontal line, the
Financial Assets of the Foreign Country and Domestic Country are perfect
substitutes across the countries, there shall be no restrictions on the Capital
flows, also, any small deviation in the domestic Interest Rates shall have
indefinite amount of Capital Flows. If, the Domestic Interest Rate is higher
than the Foreign Interest Rate then there is Capital Inflow and Vice –Versa.
Mobile Capital Flows: - The BOP Curve is a Flatter than the LM curve, the
Financial Assets not perfectly substitutes across the countries Its not a
Horizontal Line. There are Partial restriction I the Capital Mobility.
Immobile Capital Flows: - The BOP curve is steeper than the LM Curve and
the Capital Mobility is Immobile.
Also, the CA (Current Account) and KA (Capital Account) offset each other
with increase in the Exchange Rates ->Increased Exports-> Federal or
Central Banks increase the Interest rates to induce the Capital Inflows!
 The BOP equilibrium:-Has to be a
required condition, attracts the
following domestic interest rates,
i-d, leading to additional capital
inflows leading to the
additional capital inflows, more
inflows shall be, more credit
causes the BOP Surplus.
Depending on the interest rate
regime. The overall equilibrium depends on the exchange rate regimes, under the
fixed rate the Central banks buy/ sell the domestic currency to counteract and the
exchange rate regime attain the equilibrium. Thus the current account, capital account
counter react and balances/ offset each other to keep the BOP in equilibrium.