Krugman3ech34 -...

chapter
19(34)
Open-Economy
Macroeconomics
BEFORE YOU READ THE CHAPTER
Summary
This 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 the
distinction between nominal and real exchange rates and emphasizes the importance of the
real exchange rate in the current account. The chapter discusses different exchange rate
regimes and contrasts fixed exchange rate regimes with floating exchange rate regimes. Finally,
the chapter considers the effect of open economies on macroeconomic policy when operating
under a floating exchange rate regime.
Chapter Objectives
Objective #1. The balance of payments accounts summarize a country’s transactions with
other countries.
•
The balance of payments on financial account is the difference between a country’s sales
of assets to foreigners and the country’s purchases of assets from foreigners during a given
period of time. This is also referred to as the capital account. The financial account can be
broken 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 exports
and its imports plus net international transfer payments and factor income during a given
period 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 income
payments received from foreigners and payments paid to foreigners.
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C 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 CA is a positive number, then
FA must be a negative number; conversely, if CA is a negative number, then FA must be a
positive number.
Objective #2. A modified circular flow diagram can illustrate the flows between a country
and the rest of the world.
•
One flow represents the payments that are counted in the balance of payments on current
account: 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, and
the rest of the world receives payments from the country for the goods and services (this
would be payments for the country’s imports), factor income, and transfers.