Ch. 31 Open-Economy Macroeconomics: Basic Concepts

Why does S = I + NCO (Saving = Domestic Investment + Net Capital Outflow)?

A nation's saving must equal its domestic investments plus its net capital outflow.

Balanced trade

A situation in which exports equal imports.

Purchasing Power Parity

A theory of exchange rates whereby a unit of any given currency should be able to buy the same quality of goods in all countries.

Closed economy

An economy that does not interact with other economies in the world.

Open economy

An economy that interacts freely with other economies around the world.

Trade surplus

An excess of exports over imports.

Trade Deficit

Exports < Imports Net Exports < 0 Y < C + I + G Saving < Investment Net Capital Outflow < 0

Balanced Trade

Exports = Imports Net Exports = 0 Y = C + I + G Saving = Investment Net Capital Outflow = 0

Trade Surplus

Exports > Imports Net Exports > 0 Y > C + I + G Saving > Investment Net Capital Outflow > 0

What is Net Capital Outflow's importance?

For an economy as a whole, net capital outflow (NCO) must always equal net exports (NX).

Imports

Goods and services that are produced abroad and sold domestically.

Exports

Goods and services that are produced domestically.

When is Net Capital Outflow negative?

Net capital outflow is negative when domestic residents are buying less foreign assets than foreigners are buying domestic assets.

When is Net Capital Outflow positive?

Net capital outflow is positive when domestic residents are buying more foreign assets than foreigners are buying domestic assets.

How do you compute a real exchange rate?

Real Exchange Rate = Nominal exchange rate * Domestic price / Foreign price

Net Capital Outflow

The difference between the purchase of foreign assets by domestic residents and the purchase of domestic assets by foreigners.

Hyperinflation

The high inflation that arises when a government turns to the printing press pay for government spending.

Nominal exchange rate

The rate at which a person can trade the currency of one country for the currency of another.

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.

Trade balance

The value of a nation's exports minus the value of its imports; also called net exports.

Net exports

The value of a nation's exports minus the value of its imports; also called the trade balance.

What does S = I + NCO (Saving = Domestic Investment + Net Capital Outflow) mean to the U.S. economy?

When U.S. citizens save a dollar of their income for the future, that dollar can be used to finance accumulation of domestic capital or it can be used to finance the purchase of capital abroad.

foreign direct investment

When a domestic resident buys and controls capital in a foreign country.

Foreign portfolio investment

When a domestic resident buys stock in a foreign corporation but has no direct control of the company.

When does a currency depreciate?

When the exchange rate changes so, a dollar buys less foreign currency.

When does a currency appreciate?

When the exchange rate changes so, a dollar buys more foreign currency.

Trade deficit

An excess of imports over exports.

Why does NCO = NX (Net Capital Outflow = Net Exports)?

Arises because every transaction that affects NX also affects NCO by the same amount and vice versa.

Purchasing Power Parity's limits

Many goods are not easily traded, and Foreign, domestic goods are not always perfect substitutes.

What are the most important variables affecting Net Capital Outflow?

Real interest rates paid on foreign assets, Real interest rates paid on domestic assets, Perceived economic and political risks of holding assets abroad and Government policies that affect foreign ownership of domestic assets