The Open Economy
5
C H A P T E R
F I V E
The Open Economy
No nation was ever ruined by trade.
— Benjamin Franklin
Even if you never leave your home town, you are an active participant in a global economy.When you go to the grocery store, for instance, you might choose between apples grown locally and grapes grown in Chile. When you make a deposit into your local bank, the bank might lend those funds to your next-door neighbor or to a Japanese company building a factory outside Tokyo. Because our economy is integrated with many others around the world, consumers have more goods and services from which to choose, and savers have more opportunities to invest their wealth.
In previous chapters we simplified our analysis by assuming a closed economy.
In actuality, however, most economies are open: they export goods and services abroad, they import goods and services from abroad, and they borrow and lend in world financial markets. Figure 5-1 gives some sense of the importance of these international interactions by showing imports and exports as a percentage of GDP for seven major industrial countries. As the figure shows, imports and exports in the United States are more than 10 percent of GDP. Trade is even more important for many other countries—in Canada and the United Kingdom, for instance, imports and exports are about a third of GDP. In these countries, international trade is central to analyzing economic developments and formulating economic policies.
This chapter begins our study of open-economy macroeconomics.We begin in Section 5-1 with questions of measurement. To understand how the open economy works, we must understand the key macroeconomic variables that measure the interactions among countries. Accounting identities reveal a key insight: the flow of goods and services across national borders is always matched by an equivalent flow of funds to finance capital accumulation.
In Section 5-2 we examine the determinants of these international flows. We
C H A P T E R
F I V E
The Open Economy
No nation was ever ruined by trade.
— Benjamin Franklin
Even if you never leave your home town, you are an active participant in a global economy.When you go to the grocery store, for instance, you might choose between apples grown locally and grapes grown in Chile. When you make a deposit into your local bank, the bank might lend those funds to your next-door neighbor or to a Japanese company building a factory outside Tokyo. Because our economy is integrated with many others around the world, consumers have more goods and services from which to choose, and savers have more opportunities to invest their wealth.
In previous chapters we simplified our analysis by assuming a closed economy.
In actuality, however, most economies are open: they export goods and services abroad, they import goods and services from abroad, and they borrow and lend in world financial markets. Figure 5-1 gives some sense of the importance of these international interactions by showing imports and exports as a percentage of GDP for seven major industrial countries. As the figure shows, imports and exports in the United States are more than 10 percent of GDP. Trade is even more important for many other countries—in Canada and the United Kingdom, for instance, imports and exports are about a third of GDP. In these countries, international trade is central to analyzing economic developments and formulating economic policies.
This chapter begins our study of open-economy macroeconomics.We begin in Section 5-1 with questions of measurement. To understand how the open economy works, we must understand the key macroeconomic variables that measure the interactions among countries. Accounting identities reveal a key insight: the flow of goods and services across national borders is always matched by an equivalent flow of funds to finance capital accumulation.
In Section 5-2 we examine the determinants of these international flows. We