The Open Economy

Abstract

The analysis of the behaviour of the open economy, with trade in goods and services and inflows and outflows of capital, brings us closer to the typical problems of the real economy. While the ideas discussed in the last chapter might be applied to the world as a whole, important new considerations now appear which affect the economic behaviour of one country among many. We have seen how views about the determination of the supply of goods and services affects the analysis of inflation and employment in the closed economy. In the open economy, trade offers additional sources of supply which require that the stories about employment and inflation be amended. Trade, capital flows and changes in exchange rates create new transmission mechanisms, through which economic change in one country can be transmitted to another. Consideration of these relationships not only raises the need for a re-examination of the effects of stabilisation policies on employment and inflation, but also wider questions about the capacity of an individual economy to pursue such policies independently of the behaviour of the rest of the world.