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chapter19(34)Open-EconomyMacroeconomicsBEFORE YOU READ THE CHAPTER SummaryThis chapter introduces the balance of payments and explores its measurement. In addition,the chapter considers the determinants of international capital flows and the role of the for-eign exchange market and the exchange rate in the macroeconomy. The chapter explains thedistinction between nominal and real exchange rates and emphasizes the importance of thereal exchange rate in the current account. The chapter discusses different exchange rateregimes and contrasts fixed exchange rate regimes with floating exchange rate regimes. Finally,the chapter considers the effect of open economies on macroeconomic policy when operatingunder a floating exchange rate regime.Chapter ObjectivesObjective #1.The balance of payments accounts summarize a country’s transactions withother countries. •The balance of payments on financial account is the difference between a country’s salesof assets to foreigners and the country’s purchases of assets from foreigners during a givenperiod of time. This is also referred to as the capital account. The financial account can bebroken into subaccounts, including the private net purchases of assets by private individ-uals, and the official net purchases of assets, which represent transactions made by cen-tral banks. •The balance of payments on current account is the difference between a country’s exportsand its imports plus net international transfer payments and factor income during a givenperiod of time. Net international transfer payments is the difference between the pay-ments foreigners send into the country and the payments that are sent out of the coun-try to foreigners, while net international factor income is the difference between incomepayments received from foreigners and payments paid to foreigners. 679
680C H A P T E R 1 9 ( 3 4 )OPEN-ECONOMY MACROECONOMICS•The sum of the balance of payments on current account (CA) and the balance of pay-ments on financial account (FA) must equal zero. Thus, if CAis a positive number, thenFAmust be a negative number; conversely, if CAis a negative number, then FAmust be apositive number. Objective #2.A modified circular flow diagram can illustrate the flows between a countryand the rest of the world.•One flow represents the payments that are counted in the balance of payments on currentaccount: here, the rest of the world sends payments into the country for goods and serv-ices (this would be payments for the country’s exports), factor income, and transfers, andthe rest of the world receives payments from the country for the goods and services (thiswould be payments for the country’s imports), factor income, and transfers.