Open-Economy Macroeconomics Notes

Ch28 “Open-Economy Macroeconomics”

FOREIGN TRADE AND ECONOMIC ACTIVITY

Imports goods and services produced abroad and consumed domestically

Exports goods and services produced domestically and purchased by foreigners

Net exports defined as exports of goods and services minus imports of goods and services

Net foreign investment counterpart of net exports

* Denotes net US savings abroad and is approximately equal to the value of net exports

Domestic expenditures equal to consumption plus domestic investment plus government purchases

* The volume and value of imports will be affected by domestic output and the relative prices of domestic and foreign goods

Marginal propensity to import the increase in the dollar value of imports for each $1 increase in GDP

* Because a fraction of any income leaks into imports in an open economy, the open-economy multiplier is smaller than the multiplier for a closed economy.

* OPEN ECONOMY Multiplier = 1/ (MPS + MPm)

* Where MPS = marginal propensity to save and MPm = marginal propensity to import

Real exchange rate corrects for movements in the price levels in different countries

Overvalued currency one whose value is high relative to its long-run or sustainable level

High mobility of financial capital when financial investments can flow easily among countries and the regulatory barriers to financial investments are low

* Foreign trade produces a new and powerful link in the monetary transmission mechanism when a country has a flexible exchange rate. When monetary policy changes interest rates, this affects exchange rates and net exports as well as domestic investment. Monetary tightening leads to an appreciation in the exchange rate and a corresponding decline in net exports; monetary easing does the opposite. The impact of changes in interest rates on net exports reinforces the impact on domestic investment

* In a full-employment closed economy (always holding other things...