A Macroeconomic Theory of the Open Economy

Vocabulary and key concepts from the 'A Macroeconomic Theory of the Open Economy' lecture, covering loanable funds, foreign-currency exchange markets, and policy impacts.

Open-Economy Model

A model used to determine an economy's trade balance and the real exchange rate by focusing on the market for loanable funds and the market for foreign-currency exchange.

Market for Loanable Funds

A single financial market where all savers and borrowers interact, characterized by the identity $S = I + NCO$.

National saving ($S$)

The source of supply in the market for loanable funds; it increases as the real interest rate increases.

Demand for Loanable Funds

The combined demand from domestic investment ($I$) and net capital outflow ($NCO$).

Real interest rate ($r$)

The price that adjusts to balance the supply and demand for loanable funds.

Fundamental Identity of Foreign-Currency Exchange

The identity expressed as $NCO = NX$, where net capital outflow equals net exports.

Supply of Dollars (US Perspective)

In the foreign-currency exchange market, dollars supplied for the purpose of buying foreign assets ($NCO$); this curve is vertical because it depends on the real interest rate, not the exchange rate.

Demand for Dollars (US Perspective)

In the foreign-currency exchange market, dollars demanded by foreigners to buy domestic goods ($NX$).

Real exchange rate

The price that adjusts to balance the supply and demand of dollars; a higher rate makes domestic goods more expensive, reducing $NX$.

Market for Foreign-Currency Exchange (Korea/Non-Reserve)

A market where demand for dollars comes from $NCO$ (Koreans buying foreign assets) and supply comes from $NX$ (serving foreign markets).

Net Capital Outflow ($NCO$)

The variable that links the loanable funds and foreign-currency exchange markets, negatively related to the real interest rate ($r$).

Government Budget Deficit Impact

Reduces national saving, shifting the supply of loanable funds left, which increases the real interest rate and reduces $NCO$.

Crowding out

The reduction in domestic investment resulting from an increase in the real interest rate due to a government budget deficit.

Twin Deficits

The phenomenon where government budget deficits lead to trade deficits because currency appreciation reduces net exports ($NX$).

Import Quota

A trade policy that reduces imports and increases demand for dollars, leading to currency appreciation while leaving the overall trade balance ($NX$) unchanged.

Capital Flight

A large and sudden movement of funds out of a country due to increased perceived risk, such as the case of Mexico in 1994.

Mexican Capital Flight (1994) Effects

Increased Mexico's $NCO$ and demand for loanable funds, causing real interest rates to rise and the peso to depreciate sharply.

U.S. Impact of Mexican Capital Flight

Causes a decrease in U.S. $NCO$, leading to lower U.S. interest rates and a stronger U.S. dollar.