Tuesday, November 22, 2016
Chapter 12: Open-Economy Macroeconomics: Basic Concepts
• One of the ten principles of economics highlighted in Chapter 1 is that trade can
make everyone better off.
• Closed economy: an economy that does not interact with other economies in the
Open economy: an economy that interacts freely with other economies around the
The International Flows of Goods and Capital
• Exports: goods and services that are produced domestically and sold abroad
• Imports: goods and services that are produced abroad and sold domestically
• Net exports (or trade balance): the value of a nation’s exports minus the value of its
The Flow of Financial Resources: Net Capital Outﬂow
• **Net Capital Outﬂow: the purchase of foreign assets by domestic residents minus
the purchase of domestic assets by foreigners
• Some of the variables that inﬂuence net capital outﬂow (NCO):
• Real interest rates being paid on foreign assets
• Real interest rates being paid on domestic assets
• Perceived economic and political risks of holding assets abroad
• Government policies that affect foreign ownership of domestic assets
The Equality of Net Exports and Net Capital Outﬂow
• Net exports measure an imbalance between a country’s exports and its imports.
• Net capital outﬂow measures an imbalance between the amount of foreign assets
bought by domestic residents and the amount of domestic assets bought by
• That is, net capital outﬂow (NCO) always equals net exports (NX):
This equation holds because every transaction that affects
NCO = NX one side of this equation must also affect the other side by
exactly the same amount. This equation is an identity.
1 Tuesday, November 22, 2016
• When NX > 0, the country is selling more goods ad services to foreigners than it is
buying from them.
• What is it doing with the foreign currency it receives from the net sale of goods and
• It must be using it to buy foreign assets.
• Capital is ﬂowing out of the country (e.g. NCO > 0)
• When NX < 0, the country is buying more goods and services from foreigners than it
is selling to them.
• How is it ﬁnancing the net purchase of these goods and services in world markets?
• It must be seeing assets abroad.
• Capital is ﬂowing into the country (e.g. NCO < 0)
Saving, Investment, and Their Relationship to the International Flows
Saving, investment, and international capital ﬂows are inextricably linked.
Y = C +I +G+XN
Closed Y C G = I +XN
Econom S = I + XN
S = I + NCO
NCO =0 S = I
International Flows of Goods and Capital: Summary
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The Prices for International Transactions: Real and Nominal Exchange Rates
• Two important international prices discussed here:
1. The nominal x-rate
2. The real x-rates
Nominal Exchange Rates
• Nominal exchange rate: the rate at which a person can trade the currency of one
country for the currency of another
• Appreciation: an increase in the value of a currency as measured by the amount of
foreign currency it can buy
• Depreciation: a decrease in the value of a currency as measured by the amount of
foreign currency it can buy
NOTE: For example, when the exchange rate rises from 80 to 90 yen per dollar, the dollar is said to
appreciate. At the same time, because a Japanese yen now buys less of the Canadian currency, the yen
is said to depreciate. When the exchange rate falls from 80 to 70 yen per dollar, the dollar is said to
depreciate, and the yen is said to appreciate.
Real Exchange Rates
Real exchange rate: the rate at which a person can trade the goods and services of
one country for the goods and services of another
• It is a key determinant of how much a country exports and imports
Nominal x-rate⇥ Domestic price
Real x-rate =
Suppose that a bushel of Canadian wheat sells for $200, and a bushel of Russian
wheat sells for 1600 rubles. What is the real exchange rate between Canadian and
Russian wheat? To answer this question, we must ﬁrst use the nominal exchange rate
to convert the prices into a common currency. If the nominal exchange rate is 4 rubles
per dollar, then a price for Canadian wheat of $200 per bushel is equivalent to 800
rubles per bushel. Canadian wheat is half as expensive as Russian wheat. The real
exchange rate is one-half bushel of