mankiw7e-chap05 - Chapter 5: The Open Economy...

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1 CHAPTER 5 The Open Economy Chapter 5: The Open Economy In this chapter, you will learn: accounting identities for the open economy the small open economy model what makes it “small” how the trade balance and exchange rate are determined how policies affect trade balance & exchange rate
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Imports and exports  (% of GDP), 2007 Imports Exports
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3 CHAPTER 5 The Open Economy In an open economy, spending need not equal output saving need not equal investment
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4 CHAPTER 5 The Open Economy Preliminaries EX = exports = foreign spending on domestic goods IM = imports = C f + I f + G f = spending on foreign goods NX = net exports ( a.k.a. the “trade balance”) = EX IM d f C C C = + d f I I I = + d f G G G = + superscripts: d = spending on domestic goods f = spending on foreign goods
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5 CHAPTER 5 The Open Economy GDP = expenditure on  d d d Y C I G EX = + + + ( ) ( ) ( ) f f f C C I I G G EX = - + - + - + ( ) f f f C I G EX C I G = + + + - + + C I G EX I M = + + + - C I G NX = + + +
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6 CHAPTER 5 The Open Economy The national income identity  in an open economy Y  =  C  +  I  +  G  +  NX or,     NX     Y     –    ( C     I    +  G   ) net exports domestic spending output
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7 CHAPTER 5 The Open Economy Trade surpluses and deficits trade surplus: output > spending and exports > imports Size of the trade surplus = NX trade deficit: spending > output and imports > exports Size of the trade deficit = NX NX    =   EX   –  IM    =   Y     –    ( C      +  )
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8 CHAPTER 5 The Open Economy International capital flows Net capital outflow = S   –  I = net outflow of “loanable funds” = net purchases of foreign assets the country’s purchases of foreign assets minus foreign purchases of domestic assets When S   >  I , country is a net lender When S   <  I , country is a net borrower
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9 CHAPTER 5 The Open Economy NX     Y     –    ( C     I     ) implies NX    =  ( Y     –  C     –  ) –   I    =          S       –     I trade balance = net capital outflow Thus, a country with a trade deficit ( NX < 0 ) is a net borrower ( S  <   ).
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Saving, investment, and the trade balance  (percent of GDP) 1960-2007 trade balance (right scale) saving investment
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11 CHAPTER 5 The Open Economy U.S.: “The world’s largest debtor nation” Every year since 1980s: huge trade deficits and net capital inflows, i.e. net borrowing from abroad As of 12/31/2008: U.S. residents owned $19.9 trillion worth of foreign assets Foreigners owned $23.4 trillion worth of U.S. assets U.S. net indebtedness to rest of the world: $3.5 trillion--higher than any other country, hence U.S. is the “ world’s largest debtor nation
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12 CHAPTER 5 The Open Economy Saving and investment in a 
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mankiw7e-chap05 - Chapter 5: The Open Economy...

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