Unit 10: Open-Economy Macroeconomics
What changes once a country trades and borrows abroad: the balance of payments, currency markets, and the loop linking interest rates to net exports.
10 topics · 38 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
Net Exports and the Trade Balance
- How it worksHow does subtracting the value of imports from the value of exports produce a country's net exports?
- Worked exampleFind net exports for a country with 2.4 trillion dollars in exports and 3.1 trillion dollars in imports.
- Common mistakeWhy isn't a trade deficit proof that a country is losing?
Your turn1 of 2
Find net exports for a country with 3.04 trillion dollars in exports and 3.8 trillion dollars in imports.The Balance of Payments: Current and Financial Accounts
- How it worksWalk me through what lands in the current account and what lands in the financial account of the balance of payments.
- Worked exampleFind the financial account balance when the current account runs an 800 billion dollar deficit and the two accounts must sum to zero.
- Common mistakeWhy doesn't a current account deficit mean that dollars are simply disappearing overseas?
- Ties togetherHow does a current account deficit turn, dollar for dollar, into foreign ownership of domestic assets?
Your turn1 of 2
Find the financial account balance when the current account runs an 927 billion dollar deficit and the two accounts must sum to zero.The Saving-Investment Identity in an Open Economy
- How it worksHow does the identity S minus I equal net exports connect a country's saving and investment gap to its trade balance?
- Worked exampleFind net exports when national saving is 3.6 trillion dollars and domestic investment is 4.1 trillion dollars.
- Common mistakeWhy isn't a country's trade balance something that can be explained by trade policy alone, separately from its saving and investment?
- Going furtherWhat happens to net exports when a jump in domestic investment is not matched by any rise in national saving?
- Ties togetherHow does the open-economy identity S minus I equals NX reduce back to the closed-economy identity S equals I once trade is shut down?
Your turn1 of 2
Find net exports when national saving is 4.04 trillion dollars and domestic investment is 4.8 trillion dollars.Exchange Rates, Appreciation, and Depreciation
- How it worksHow does an exchange rate quoted in one direction, dollars per euro, say exactly the same thing quoted the other way around?
- Worked exampleFind how many euros one dollar buys when one euro costs 1.25 dollars.
- Common mistakeWhy isn't a stronger currency automatically good news for every part of a country's economy?
- Going furtherWhat happens to the price of an imported car once the dollar appreciates by 20 percent against the currency it was priced in?
Your turn1 of 2
Find how many euros one dollar buys when one euro costs 1.248 dollars.The Foreign Exchange Market
- How it worksWalk me through drawing the market for dollars with the exchange rate sitting on the vertical axis.
- Common mistakeWhy isn't demand for a country's currency the same thing as demand for that country's goods?
- Going furtherWhat happens to a currency's price when demand for it rises while its supply stays fixed?
Your turn1 of 2
In the market for dollars, demand for dollars is downward-sloping with a demand slope of 4 and supply is upward-sloping with a supply slope of 4, both against the exchange rate E in yen per dollar. If demand for dollars shifts so that 190 more dollars are demanded at every exchange rate, by how much does the equilibrium exchange rate rise?Purchasing Power Parity
- How it worksHow does the law of one price, applied to an entire basket of goods, predict where an exchange rate should eventually settle?
- Worked exampleFind the exchange rate purchasing power parity predicts when a basket costs 100 dollars in the United States and 9000 yen in Japan.
- Common mistakeWhy doesn't purchasing power parity predict an exchange rate accurately from one day to the next?
- Going furtherWhat happens to a currency's purchasing-power-parity value once one country's inflation runs far ahead of the other's?
Your turn1 of 2
Find the exchange rate purchasing power parity predicts when a basket costs 129 dollars in the United States and 12543 yen in Japan.Interest Rates and International Capital Flows
- How it worksHow does a higher domestic real interest rate pull in foreign capital and lift demand for the domestic currency?
- Common mistakeWhy isn't a country with high interest rates automatically a country with a strong, healthy economy?
- Going furtherWhat happens to capital flows between two countries offering the same nominal rate but very different inflation rates?
- Ties togetherHow do capital inflows drawn in by a high interest rate show up on the supply side of the loanable funds market?
Your turn1 of 2
Net capital inflow rises by 31 billion dollars for every 1 percentage point the domestic real interest rate rises above the world rate. If the domestic rate rises from 3 to 6.83 percent, what is the change in net capital inflow?How a Rate Change Travels to the Currency Market and Back to Net Exports
- How it worksWalk me through a higher real interest rate pulling in capital, strengthening the currency, and shrinking net exports.
- Worked exampleFind the direction net exports move when a rise in the real interest rate strengthens the domestic currency.
- Common mistakeWhy doesn't a policy that raises real output always strengthen a country's currency at the same time?
- Going furtherWhat happens to this whole chain when the interest rate change comes from expansionary fiscal policy rather than tighter monetary policy?
Your turn1 of 2
A rise in the real interest rate strengthens the domestic currency, which reduces net exports by 12 billion dollars for every 1 percent the currency appreciates. If the currency appreciates by 8 percent, how much do net exports fall?Twin Deficits: Fiscal Policy and the Trade Balance
- How it worksWalk me through a budget deficit raising the real interest rate, pulling in foreign capital, and shrinking net exports.
- Worked exampleFind the change in net capital inflow and net exports when the real interest rate rises and foreign capital responds by flowing in.
- Common mistakeWhy isn't a capital inflow drawn in by government borrowing automatically a sign the country is winning?
- Going furtherWhat happens to the twin-deficits link when higher government borrowing crowds out private investment instead of pulling in foreign capital?
Your turn1 of 2
Find the change in net capital inflow when the real interest rate rises by 2.12 percentage points and foreign capital responds by flowing in at 32 billion dollars per percentage point.Fixed Versus Floating Exchange Rate Regimes
- How it worksHow does a central bank defending a fixed exchange rate have to buy and sell its own currency to hold the rate steady?
- Common mistakeWhy isn't a fixed exchange rate free to maintain no matter how large the gap grows between supply and demand for the currency?
- Going furtherWhat happens to a country's own monetary policy independence once it commits to a fixed exchange rate?
Your turn1 of 2
A country commits to a fixed exchange rate, but market forces are pushing its currency to weaken beyond the pegged level. What must the central bank do to defend the fixed rate?