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Open-Economy Macroeconomics
Most countries have open economies.
- They import and export goods and services
- About 10% of GDP in the USA
- They borrow and lend in world financial markets.
- The flow of goods and services across national borders is always matched
by an equivalent flow of funds to finance capital accumulation.
The National Income Identity in an Open-Economy
The total expenditure on domestic output is the sum of consumption, investment,goverment purchases, and net exports
Y = C + I + G + NX
- Y, output
- C, consumption of domestic goods and services
- I, investment in domestic goods and services
- G, government purchases of domestic goods and services
- NX, another name for net exports is the trade balance
- ( C + I + G ) , domestic spending
- S = ( Y - C - G ) , Savings
The national income accounts identity
tell us:
S - I = NX
- Net capital outflow, the difference between domestic
savings and domestic investments S - I,
must equal net exports.
Exchange Rate
The Real Exchange Rate measures the number of foreign goods one can exchange for one comparable domestic good. It incorporates the relative price levels of the countries as well as the Nominal Exchange rate.
In the long run, if the Japanese goverment places high tariffs on all imports, that country's real foreign exchange rate increases.
Slower growth in the German money supply will lead to a depreciation of the dollar relative to the German Mark.
Type of Trades:
Tax Cuts:
If a government of a small open economy increases personal taxes or investment demand decreases, the net exports increase.
A tax cut in a small open economy with a constant world interest rate, full employment, and an initial trade surplus of zero result in:
- a negative net capital outflow
- a trade deficit
- a reduccion in national saving
In a large open economy an increase in government purchases or a reduction in taxes causes:
- an increase in the real interest rate
- a reduction in net capital outflow
- an increase in the real exchange rate
In a large open economy an increase in the investment tax credit, which increases investment demand, will:
- increase the real interest rate
- reduce net capital outflow
- decrease net exports
If the government of several large foreign countris raise taxes, the real exchange rate of the dollar will rise.
Assumptions: Capital Flows
- domestic and foreign bonds are perfect substitutes
- perfect capital mobility
- a small economy cannot affect the world interest rate
Hypothesis, theorems and terms
According to Macroeconomics by Gregory Mankiw
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