Open-Economy Macroeconomics

Before I built a wall I’d ask to know

What I was walling in or walling out . . .
Robert Frost

The international business cycle exerts a powerful

effect on every nation of the globe. Shocks in one area
can have ripple effects around the world.

A. FOREIGN TRADE AND

ECONOMIC ACTIVITY
Open-economy macroeconomics is the study of
how economies behave when the trade and financial
linkages among nations are considered.

Total aggregate demand = C+I+G+X

Net Exports and Output

in the Open Economy
Foreign trade involves imports and exports.
Although the United States produces most of what
it consumes, it nonetheless has a large quantity of
imports, which are goods and services produced
abroad and consumed domestically. Exports are
goods and services produced domestically and purchased
by foreigners.

Net exports are defi ned as exports of goods and

services minus imports of goods and services.

X= Ex – Im

When a country has positive net exports, it is accumulating

foreign assets. The counterpart of net
exports is net foreign investment, which denotes
net U.S. savings abroad and is approximately equal
to the value of net exports. Because the U.S. had
negative net exports, its net foreign investment
was negative, implying that the U.S. foreign indebtedness
was growing.

Total domestic output =GDP

=C+G+I+X

Determinants of Trade and Net Exports

What determines the levels of exports and imports

and therefore of net exports?

Imports into the United States are positively

related to U.S. income and output. When U.S. GDP
rises, imports into the U.S. increase
(1) because some of the increased C +I +G purchases (such as
cars and shoes) come from foreign production and
also
(2) because America uses foreign-made inputs
(like oil or lumber) in producing its own goods.

If the price of domestic

cars rises relative to the price of Japanese cars,
say, because the dollar’s exchange rate appreciates,
Americans will buy more Japanese cars and fewer
American ones. Hence the volume and value of imports
will be affected by domestic output and the relative prices of
domestic and foreign goods.

Exports are the mirror image of imports: U.S.

exports are other countries’ imports.

Graph showing the deficit in net exports of US

Figure 28-2 shows the open-economy equilibrium

graphically. The upward-sloping blue line
marked C+ I +G is the same curve used in Figure
22-10. To this line we must add the level of net
exports that is forthcoming at each level of GDP.

Gray is blue, pink is green.

When the green line lies below the blue

curve, imports exceed exports and net exports are
negative. When the green line is above the blue line,
the country has a net-export surplus and output is
greater than domestic demand.

Equilibrium GDP occurs where the green line of

total spending intersects the 45° line. This intersection
comes at exactly the same point, at $3500 billion,
that is shown as equilibrium GDP in Table 28-1.
Only at $3500 billion does GDP exactly equal what
consumers, businesses, governments, and foreigners
want to spend on goods and services produced in the
domestic economy.