Open Economy

Open Economy

The Role of Net Exports

• Cd, consumption of domestic goods and services, Id, investment in domestic goods and services, Gd, government purchases of domestic goods and services, X, exports of domestic goods and services.

International Capital Flows and the Trade Balance

The national income accounts identity shows that the international flow of funds to finance capital accumulation and the international flow of goods and services are two sides of the same coin.

Saving and Investment in a Small Open Economy

• r = r*

How Policies Influence the Trade Balance

• Fiscal Policy at Home: Hence, starting from balanced trade, a change in fiscal policy that reduces national saving leads to a trade deficit.
• Fiscal Policy Abroad: Hence, starting from balanced trade, an increase in the world interest rate due to a fiscal expansion abroad leads to a trade surplus

• Shifts in Investment Demand: Hence, starting from balanced trade, an outward shift in the investment schedule causes a trade deficit.

Exchange Rates

• The Nominal Exchange Rate: The nominal exchange rate is the relative price of the currencies of two countries.
• The real exchange rate is the relative price of the goods of two countries. That is, the real exchange rate tells us the rate at which we can trade the goods of one country for the goods of another. The real exchange rate is sometimes called the terms of trade.

The Determinants of the Real Exchange Rate

How Policies Influence the Real Exchange Rate

• Fiscal Policy at Home