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Chapter 32
A Macroeconomic Theory
of the Open Economy
Open Economies
• An open economy is one that interacts
freely with other economies around the
world.
Key Macroeconomic Variables in
an Open Economy
• The important macroeconomic variables of
an open economy include:
– net exports
– net foreign investment
– nominal exchange rates
– real exchange rates
Basic Assumptions of a
Macroeconomic Model of an Open
Economy
• The model takes the economy’s GDP as
given.
• The model takes the economy’s price level
as given.
32.1 SUPPLY AND DEMAND FOR
LOANABLE FUNDS AND FOR
FOREIGN-CURRENCY EXCHANGE
• The Market for Loanable Funds
S = I + NCO
– At the equilibrium interest rate, the amount
that people want to save exactly balances the
desired quantities of investment and net capital
outflows.
32.1.1 The Market for Loanable
Funds
• The supply of loanable funds comes from
national saving (S).
• The demand for loanable funds comes from
domestic investment (I) and net capital
outflows (NCO).
32.1.1 The Market for Loanable Funds
• The supply and demand for loanable funds
depend on the real interest rate.
• A higher real interest rate encourages people to
save and raises the quantity of loanable funds
supplied.
• The interest rate adjusts to bring the supply and
demand for loanable funds into balance.
Figure 1 The Market for Loanable Funds
Real
Interest
Rate
Supply of loanable funds
(from national saving)
Equilibrium
real interest
rate
Demand for loanable
funds (for domestic
investment and net
capital outflow)
Equilibrium
quantity
Quantity of
Loanable Funds
32.1.1 The Market for Loanable
Funds
• At the equilibrium interest rate, the
amount that people want to save exactly
balances the desired quantities of domestic
investment and net foreign investment.
32.1.2 The Market for ForeignCurrency Exchange
• The two sides of the foreign-currency exchange
market are represented by NCO and NX.
NCO = NX
Net capital outflow = Net exports.
• NCO represents the imbalance between the
purchases and sales of capital assets.
• NX represents the imbalance between exports and
imports of goods and services.
32.1.2 The Market for ForeignCurrency Exchange
• In the market for foreign-currency exchange,
U.S. dollars are traded for foreign
currencies.
• For an economy as a whole, NCO and NX
must balance each other out, or:
NCO = NX
32.1.2 The Market for ForeignCurrency Exchange
• Net capital outflow represents the quantity of
dollars supplied for the purpose of buying
foreign assets.
• For example, when a U.S. mutual fund wants to
buy a Japanese government bond, it needs to
change dollars into yen, so it supplies dollars in
the market for foreign-currency exchange.
32.1.2 The Market for Foreign-Currency
Exchange
• Net exports represents the quantity of dollars
demanded for the purpose of buying U.S. net
exports of goods and services.
• For example, when a Japanese airline wants to
buy a plane made by Boeing, it needs to change
its yen into dollars, so it demands dollars in the
market for foreign-currency exchange.
• The price that balances the supply and demand
for foreign-currency is the real exchange rate.
32.1.2 The Market for Foreign-Currency
Exchange
• The demand curve for foreign currency is
downward sloping because a higher
exchange rate makes domestic goods more
expensive.
• The supply curve is vertical because the
quantity of dollars supplied for net capital
outflow is unrelated to the real exchange
rate.
Figure 2 The Market for Foreign-Currency
Exchange
Real
Exchange
Rate
Supply of dollars
(from net capital outflow)
Equilibrium
real exchange
rate
Demand for dollars
(for net exports)
Equilibrium
quantity
Quantity of Dollars Exchanged
into Foreign Currency
32.1.2 The Market for Foreign-Currency
Exchange
• The real exchange rate adjusts to balance the
supply and demand for dollars.
• At the equilibrium real exchange rate, the demand
for dollars to buy net exports exactly balances the
supply of dollars to be exchanged into foreign
currency to buy assets abroad.
32.2
EQUILIBRIUM IN THE
OPEN ECONOMY
32.2.1 Net Capital Outflow: The
Link between the two Markets
• In the market for loanable funds, supply
comes from national saving and demand
comes from domestic investment and net
capital outflow.
• In the market for foreign-currency exchange,
supply comes from net capital outflow and
demand comes from net exports.
32.2.1 Net Capital Outflow: The Link
between the two Markets
•
Net capital outflow links the loanable funds
market and the foreign-currency exchange
market.
1) In the market for loanable funds, net capital
outflow is a piece of demand. A person who
wants to buy an asset abroad must finance this
purchase by obtaining resources in the market
for loanable funds.
32.2.1 Net Capital Outflow: The Link
between the two Markets
2) In the market for foreign-currency exchange,
net capital outflow is the source of supply. A
person who wants to buy an asset in another
country must supply dollars in order to exchange
for them for the currency of that country.
• The key determinant of net capital outflow is the
real interest rate. When the U.S. interest rate is
high, owning U.S.assets is more attractive, and
U.S. net capital outflow is low.
Figure 3 How Net Capital Outflow Depends on
the Interest Rate
Real
Interest
Rate
Net capital outflow
is negative.
0
Net capital outflow
is positive.
Net Capital
Outflow
32.2.2 Simultaneous Equilibrium in
Two Markets
• Prices in the loanable funds market and the
foreign-currency exchange market adjust
simultaneously to balance supply and demand in
these two markets.
• As they do, they determine the macroeconomic
variables of national saving, domestic investment,
net foreign investment, and net exports.
32.2.2 Simultaneous Equilibrium in
Two Markets
• Panel (a) of the figure shows the market for loanable funds.
As before, national saving is the source of the supply of
loanable funds. Domestic investment and net capital
outflow are the source of the demand for loanable funds.
The equilibrium real interest rate(r1) brings the quantity of
loanable funds supplied and the quantity of loanable funds
demanded into balance.
• Panel (b) of the figure shows net capital outflow.It shows
how the interest rate from panel (a) determines net capital
outflow. A higher interest rate at home makes domestic
assets more attractive, and this in turn reduces net capital
outflow. Therefore, the net capital outflow curve in panel
(b) slopes downward.
32.2.2 Simultaneous Equilibrium in
Two Markets
• Panel (c) of the figure shows the market for foreigncurrency exchange. Because foreign assets must be
purchased with foreign currency, the quantity of
net capital outflow from panel (b) determines the
supply of dollars to be exchanged into foreign
currencies. The real exchange rate does not affect
net capital outflow, so the supply curve is vertical.
The demand for dollars come from net exports.
Because a depreciation of the real exchange rate
increases net exports, the demand curve for foreigncurrency exchange slopes downward.
Figure 4 The Real Equilibrium in an Open
Economy
(a) The Market for Loanable Funds
Real
Interest
Rate
(b) Net Capital Outflow
Real
Interest
Rate
Supply
r
r
Demand
Net capital
outflow, NCO
Quantity of
Loanable Funds
Net Capital
Outflow
Real
Exchange
Rate
Supply
E
Demand
Quantity of
Dollars
(c) The Market for Foreign-Currency Exchange
32.3
HOW POLICIES AND
EVENTS AFFECT AN
OPEN ECONOMY
32.3 HOW POLICIES AND EVENTS
AFFECT AN OPEN ECONOMY
• The magnitude and variation in important
macroeconomic variables depend on the
following:
– Government budget deficits
– Trade policies
– Political and economic stability
32.3.1 Government Budget Deficits
• In an open economy, government budget
deficits . . .
– reduce the supply of loanable funds,
– drive up the interest rate,
– crowd out domestic investment,
– cause net foreign investment (NCO) to fall,
– Cause the currency to appreciate,
– Push the trade balance toward deficit.
Figure 5 The Effects of Government Budget
Deficit
(a) The Market for Loanable Funds
Real
Interest
Rate
r2
S
1. A budget deficit reduces
(b) Net Capital Outflow
the supply of loanable funds . . .
Real
Interest
Rate
S
B
r2
A
r
2. . . . which
increases
the real
interest
rate . . .
r
3. . . . which in
turn reduces
net capital
outflow.
Demand
NCO
Quantity of
Loanable Funds
Net Capital
Outflow
Real
Exchange
Rate
E2
E1
5. . . . which
causes the
real exchange
rate to
appreciate.
S
S
4. The decrease
in net capital
outflow reduces
the supply of dollars
to be exchanged
into foreign
currency . . .
Demand
Quantity of
Dollars
(c) The Market for Foreign-Currency Exchange
32.3.1 Government Budget Deficits
• Effect of Budget Deficits on the Loanable Funds
Market
– A government budget deficit reduces national
saving, which . . .
• shifts the supply curve for loanable funds to
the left, which . . .
• raises interest rates.
32.3.1 Government Budget Deficits
• Effect of Budget Deficits on Net Foreign Outflow:
– Panel (b) shows that the increase in the interest
rate from r1 to r2 reduces net capital outflow.
• Because saving kept at home now earns higher
rates of return, investing abroad is less attractive,
and domestic residents buy fewer foreign assets.
Higher interest rates also attract foreign investors,
who want to earn the higher returns on US. Assets.
• Thus, when budget deficits raise interest rates, both
domestic and foreign behavior cause US. Net
capital outflow to fall.
32.3.1 Government Budget Deficits
• Effect on the Foreign-Currency Exchange
Market
– A decrease in net foreign investment
reduces the supply of dollars to be
exchanged into foreign currency.
– This causes the real exchange rate to
appreciate.
32.3.2 Trade Policy
• A trade policy is a government policy that
directly influences the quantity of goods
and services that a country imports or
exports.
– Tariff: A tax on an imported good.
– Import quota: A limit on the quantity of a
good produced abroad and sold
domestically.
32.3.2 Trade Policy
• Because they do not change national saving or
domestic investment, trade policies do not affect
the trade balance.
– For a given level of national saving and
domestic investment, the real exchange rate
adjusts to keep the trade balance the same.
• Trade policies have a greater effect on
microeconomic than on macroeconomic markets.
32.3.2 Trade Policy
• Effect of an Import Quota
– Because foreigners need dollars to buy
U.S. net exports, there is an increased
demand for dollars in the market for
foreign-currency.
• This leads to an appreciation of the real
exchange rate.
32.3.2 Trade Policy
• Effect of an Import Quota
– An appreciation of the dollar in the
foreign exchange market encourages
imports and discourages exports.
– This offsets the initial increase in net
exports due to import quota.
Figure 6 The Effects of an Import Quota
(a) The Market for Loanable Funds
Real
Interest
Rate
(b) Net Capital Outflow
Real
Interest
Rate
Supply
r
r
3. Net exports,
however, remain
the same.
Demand
NCO
Quantity of
Loanable Funds
Net Capital
Outflow
Real
Exchange
Rate
E2
2. . . . and
causes the
real exchange
rate to
appreciate.
Supply
1. An import
quota increases
the demand for
dollars . . .
E
D
D
Quantity of
Dollars
(c) The Market for Foreign-Currency Exchange
32.3.2 Trade Policy
• Effect of an Import Quota
– There is no change in the interest rate because
nothing happens in the loanable funds market.
– There will be no change in net exports.
– There is no change in net foreign investment
even though an import quota reduces imports.
32.3.2 Trade Policy
• Effect of an Import Quota: Trade policies do not
affect the trade balance.
• That is, policies that directly influence exports or
imports do not alter net exports. This conclusion
seems less surprising if one recalls the accounting
identity:
NX = NCO = S – I
32.3.2 Trade Policy
NX = NCO = S – I
• Net exports equal net capital outflow, which equals
national saving minus domestic investment. Trade
policies do not alter the trade balance because they
do not alter national saving or domestic investment.
• For given levels of national saving and domestic
investment, the real exchange rate adjusts to keep
the trade balance the same, regardless of the trade
policies the government puts in place.
• Although trade policies do not affect a country’s
overall trade balance, these policies do affect
specific firms , industries, and countries.
32.3.3 Political Instability and Capital Flight
• In 1994 political instability in Mexico, including
the assassination of a prominent political leader,
made would financial markets nervous. People
began to view Mexico as a much less stable country
than they had previously thought. They decided to
pull some of their assets out of Mexico in order to
move these funds to the U.S. and other “safe
heaven”. Such a large and sudden movement of
funds out of a country is called capital flight.
32.3.3 Political Instability and Capital Flight
• Capital flight 资本外逃 is a large and sudden
reduction in the demand for assets located
in a country.
32.3.3 Political Instability and Capital
Flight
• Capital flight has its largest impact on the
country from which the capital is fleeing, but it
also affects other countries.
• If investors become concerned about the safety
of their investments, capital can quickly leave an
economy.
• Interest rates increase and the domestic currency
depreciates.
32.3.3 Political Instability and Capital
Flight
• This increased Mexican net capital outflow.
– The demand for loanable funds in the loanable
funds market increased, which increased the
interest rate.
– This increased the supply of pesos in the
foreign-currency exchange market.
– Decreases the value of the Mexican peso in the
market for foreign-currency exchange.
32.3.3 Political Instability and Capital
Flight
• To see the effects of capital flight on the
economy,we compare the old and new equilibria.
• Panel (a) of Figure 7 shows that the increased
demand for loanable funds causes the interest rate
in Mexico to rise from r1 to r2.
• Panel (b) shows that Mexican net capital outflow
increases. (Although the rise in the interest rate
does make Mexican assets more attractive, this only
partly offsets the impact of capital flight on net
capital outflow.)
32.3.3 Political Instability and Capital
Flight
• Panel (c ) shows that the increase in net capital
outflow raises the supply of pesos in the market for
foreign-currency exchange from S1 to S2. That is, as
people try to get out of Mexican assets, there is a
large supply of pesos to be converted into
dollars.This increase in supply causes the peso to
depreciate from E1 to E2.
• Thus, capital flight from Mexico increases Mexican
interest rates and decreases the value of the
Mexican peso in the market for foreign-currency
exchange.
32.3.3 Political Instability and Capital
Flight
• This is exactly what was observed in 1994. From
November 1994 to March 1995, the interest rate
on short-term Mexican government bonds rose
from 14 percent to 70 percent, and the peso
depreciated in value from 29 to 15 U.S. cents per
peso.
Figure 7 The Effects of Capital Flight
(a) The Market for Loanable Funds in Mexico
Real
Interest
Rate
(b) Mexican Net Capital Outflow
Real
Interest
Rate
Supply
r2
r2
r1
r1
3. . . . which
increases
the interest
rate.
1. An increase
in net capital
outflow. . .
D2
D1
NCO1
Quantity of
2. . . . increases the demand
Loanable Funds
for loanable funds . . .
NCO2
Net Capital
Outflow
Real
Exchange
Rate
E
5. . . . which
causes the
peso to
depreciate.
S
S2
4. At the same
time, the increase
in net capital
outflow
increases the
supply of pesos . . .
E
Demand
Quantity of
Pesos
(c) The Market for Foreign-Currency Exchange
Summary
• To analyze the macroeconomics of open
economies, two markets are central—the market
for loanable funds and the market for foreigncurrency exchange.
• In the market for loanable funds, the interest rate
adjusts to balance supply for loanable funds
(from national saving) and demand for loanable
funds (from domestic investment and net capital
outflow).
Summary
• In the market for foreign-currency exchange,
the real exchange rate adjusts to balance the
supply of dollars (for net capital outflow)
and the demand for dollars (for net exports).
• Net capital outflow is the variable that
connects the two markets.
Summary
• A policy that reduces national saving, such
as a government budget deficit, reduces the
supply of loanable funds and drives up the
interest rate.
• The higher interest rate reduces net capital
outflow, reducing the supply of dollars.
• The dollar appreciates, and net exports fall.
Summary
• A trade restriction increases net exports and
increases the demand for dollars in the
market for foreign-currency exchange.
• As a result, the dollar appreciates in value,
making domestic goods more expensive
relative to foreign goods.
• This appreciation offsets the initial impact
of the trade restrictions on net exports.
Summary
• When investors change their attitudes about
holding assets of a country, the ramifications for
the country’s economy can be profound.
• Political instability in a country can lead to
capital flight.
• Capital flight tends to increase interest rates and
cause the country’s currency to depreciate.
Mankiw ch.32, Questions for Review
1. Describe supply and demand in the market for
loanable funds and the market for foreigncurrency exchange. How are these markets linked?
(Mankiw,ch32, p698-702.)
2. Why are budget deficits and trade deficits
sometimes called the twin deficits?(Mankiw,p706-708.)
3. What is capital flight? When a country
experiences capital flight, what is the effect on
its interest rate and exchange rate? (Mankiw,ch32,
p712-714.)
4. How policies and events affect an open economy?
(Mankiw,ch32, p706-714.)
复习题
1.说明可贷资金市场与外汇市场的供给与需求。
这两个市场如何联系？
2. 为什么预算赤字和贸易赤字有时称为孪生赤字？
3. 假设纺织工人工会鼓励人们只购买美国制造的
衣服。这种政策对贸易余额和实际汇率有什么
影响？对纺织行业有什么影响？对汽车行业有
什么影响？
4. 什么是资本外逃？ 当一个国家发生了资本外
逃时，对利率和汇率有什么影响？