Macroeconomics Chapter 18 Notes
• One of the Ten Principles of Economics from Chapter 1: Trade can make
everyone better off
• This chapter introduces basic concepts of international macroeconomics.
➢ The trade balance (trade deficits, surpluses)
➢ International flow of assets
➢ Exchange rates
Closed versus Open Economies
• A closed economy does not interact with other economies in the world.
• An open economy interacts freely with other economies around the world.
The Flow of Goods and Services
• Exports: domestically-produced goods and services sold abroad
• Net exports (NX): aka the trade balance = value of exports – value of
Variables that Influence Net Exports
• Consumers’ preferences for foreign and domestic goods
• Prices of goods at home and abroad
• Incomes of consumers at home and abroad
• The exchange rates at which foreign currency trades for domestic currency.
• Transportation costs
• Government policies
Trade Surpluses & Deficits
• NX measures the imbalance in a country’s trade in goods and services.
• Trade deficit: an excess of imports over exports, NX < 0 and Y < C+I+G
• Trade surplus: an excess of exports over imports, NX > 0 and Y > C+I+G
• Balanced trade: when exports = imports, NX = 0 and Y=C+I+G
• Table 1, page 384 (KNOW THIS INFO)
The Increasing Openness of the US Economy
• Increasing importance of international trade and finance
➢ 1950s, imports and exports: 4-5% of GDP
➢ Recent years:
o Exports – increased more than twice
o Imports – increased more than three times
• Increase in international trade
➢ Improvements in international trade
➢ Advances in telecommunications
➢ Technological progress ➢ Governments trade policies – NAFTA and GATT
The Flow of Capital
• Net capital outflow (NCO): domestic residents’ purchases of foreign assets
minus foreigners’ purchases of domestic assets
• NCO is also called net foreign investment
• The flow of capital abroad takes two forms:
• Foreign direct investment: domestic residents or firms set up a foreign
subsidiary and actively manage the foreign investment, such as, McDonalds
opens a fast-food outlet in Moscow, Disney builds a theme park in Hong Kong
• Foreign portfolio investment: domestic residents purchase foeign stocks or
bonds, supplying “loanable funds” to a foreign firm, such as, an American
buys stock in Toyota.
• NCO measures the imbalance in a country’s trade in assets.
➢ When NCO > 0, “capital outflow”. Domestic purchases of foreign assets
exceed foreign purchases of domestic assets
➢ When NCO < 0, “capital inflow”. Foreign purchases of domestic assets exceed
domestic purchases of foreign assets.
Variables That Influence NCO
• Real interest rates paid on foreign assets.
• Real interest rates paid on domestic assets.
• Perceived risks of holding foreign assets.
• Government policies affecting foreign ownership of domestic assets.
The Equality of NX and NCO
• An accounting identity: NCO = NX
➢ Arises because every transaction that affects NX also affects NCO by the same
amount (and vice versa)
• When the foreigner purchases a good from the US.,
➢ US exports and NX increase
➢ The foreigner pays with currency or assets, so he US acquires some foreign
assets, causing NCO to rise
• When a US citizen buys foreign goods,
➢ US imports rise, NX falls
➢ The US buyer pays with the US dollars or assets, so the country acquires US
assets, causing US NCO to fall.
Savings, Investment and International Flows of Goods & Assets
• Y = C + I +G + NX accounting identity
• Y –C –G = I + NX rearranging terms
• S = I + NX since S = Y- C –G
• S = I +NCO since NX =NCO
• Thus, in an open economy, S =I +NCO • Then S – I = NCO and NX
• When S > I, then NCO > 0 and the excess loanable funds flow abroad in the
form of positive net capital outflow (trade surplus)
• When S < I, then NCO < 0 and foreigners are financing some of the country’s
investment in the form of negative net capital outflow (trade deficit)
Case Study: The US Trade Deficit
• The US trade deficit reached record levels in 2006 and remained high in
• Recall, NX = S – I = NCO
• A trade deficit means I > S, so the nation borrows the difference from
• In 2007, foreign purchases of US assets exceeded US purchases of foreign
assets by $775 million.
• Is the US trade deficit a problem?
➢ The extra capital stock from the ‘90s investment boom may well yield large
➢ The fall in saving of the ‘80s and ‘00s, while not desirable, at least did not
depress domestic investment, a