The Open EconomySlide 2Openness in Goods MarketsExports and ImportsSlide 5Slide 6Slide 7The Choice Between Domestic Goods and Foreign GoodsNominal Exchange RatesSlide 10Slide 11Slide 12Slide 13From Nominal to Real Exchange RatesSlide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23From Bilateral to Multilateral Exchange RatesSlide 25Slide 26Slide 27Openness in Financial MarketsThe Balance of PaymentsSlide 30Slide 31Slide 32The Choice Between Domestic and Foreign AssetsSlide 34Slide 35Expectations, Consumption, and Investment DecisionsInterest Rates and Exchange RatesSlide 38Slide 39Conclusions and a Look AheadC H A P T E RC H A P T E RPrepared by:Prepared by:Fernando Quijano and Yvonn QuijanoFernando Quijano and Yvonn QuijanoAnd Modified by Gabriel MartinezAnd Modified by Gabriel MartinezThe Open EconomyThe Open Economy1818© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier BlanchardThe Open EconomyThe Open EconomyOpenness has three distinct dimensions:Openness has three distinct dimensions:1.1.Openness in goods markets. Free trade Openness in goods markets. Free trade restrictions include restrictions include tariffstariffs and and quotasquotas..2.2.Openness in financial markets. Openness in financial markets. Capital Capital controlscontrols place restrictions on the ownership of place restrictions on the ownership of foreign assets.foreign assets.3.3.Openness in factor markets—the ability of firms Openness in factor markets—the ability of firms to choose where to locate production, and to choose where to locate production, and workers to choose where to work.workers to choose where to work.1.1.The The North American Free Trade Agreement North American Free Trade Agreement (NAFTA)(NAFTA) is an example of this. is an example of this.© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier BlanchardOpenness in GoodsOpenness in GoodsMarketsMarketsU.S. Exports and U.S. Exports and Imports as Ratios of Imports as Ratios of GDP, 1960-2000GDP, 1960-2000Exports and imports, which were equal to 5% of GDP as recently as the 1960s, now stand around 13% of GDP.18-1ImportsExports© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier BlanchardExports and ImportsExports and ImportsThe behavior of exports and imports in the The behavior of exports and imports in the United States is characterized by:United States is characterized by:A sharp decline in both exports and imports A sharp decline in both exports and imports between 1929 and 1936 as a result of the Smoot-between 1929 and 1936 as a result of the Smoot-Hawley Act of 1930.Hawley Act of 1930.Three episodes of surpluses and deficits:Three episodes of surpluses and deficits:The trade surpluses of the 1940s.The trade surpluses of the 1940s.The trade deficits of the mid-1980s, andThe trade deficits of the mid-1980s, andThe current trade deficit, which reached 6.63% of GDP The current trade deficit, which reached 6.63% of GDP in Q2 2006—a historical record.in Q2 2006—a historical record.© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier BlanchardOpenness in GoodsOpenness in GoodsMarketsMarketsU.S. Current U.S. Current Account Deficit as Account Deficit as a ratio of GDP, a ratio of GDP, 1960-20061960-2006Exports and imports, which were equal to 5% of GDP as recently as the 1960s, now stand around 13% of GDP.© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier BlanchardExports and ImportsExports and ImportsThe main factors behind differences in export ratios are The main factors behind differences in export ratios are geography and country size.geography and country size.Countries can have export ratios larger than the value of Countries can have export ratios larger than the value of their GDP because exports and imports may include their GDP because exports and imports may include exports and imports of intermediate goods.exports and imports of intermediate goods.Table 18-1Ratios of Exports to GDP for Selected OECD Countries, 2000CountryExport Ratio (%) Country Export Ratio (%)United StatesUnited States1111SwitzerlandSwitzerland4545JapanJapan1010AustriaAustria4848GermanyGermany3333NetherlandsNetherlands7474United KingdomUnited Kingdom2727BelgiumBelgium8484© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier BlanchardExports and ImportsExports and ImportsA good index of openness is the proportion A good index of openness is the proportion of aggregate output composed of of aggregate output composed of tradable tradable goodsgoods—goods that compete with foreign —goods that compete with foreign goods in either domestic markets or foreign goods in either domestic markets or foreign markets.markets.Estimates are that tradable goods represent Estimates are that tradable goods represent around 60% of aggregate output in the around 60% of aggregate output in the United States today.United States today.© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier BlanchardThe Choice Between DomesticThe Choice Between DomesticGoods and Foreign GoodsGoods and Foreign GoodsWhen goods markets are open, domestic When goods markets are open, domestic consumers must decide not only how much consumers must decide not only how much to consume and save, …to consume and save, …… … but also whether to buy domestic goods but also whether to buy domestic goods or to buy foreign goods.or to buy foreign goods.Central to the second decision is the price Central to the second decision is the price of domestic goods relative to foreign goods, of domestic goods relative to foreign goods, or the or the real exchange ratereal exchange rate..© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Macroeconomics, 3/e Olivier BlanchardOlivier