Macroeconomic Policy in an Open Economy

Abstract

In Chapter 3 we looked at some of the fundamental identities for an open economy and considered the possible effect of devaluation on the current account. It was noted that the ultimate impact of a devaluation will in large part be dependent upon the economic policies that accompany the devaluation. In this chapter we shall be examining how both exchange-rate changes and macroeconomic policies impact upon an open economy. A fundamental difference between an open economy and a closed economy is that over time a country has to ensure that there is an approximate balance in its current account. This is because no country can continuously build up a stock of net liabilities to the rest of the world by running a continuous current account deficit. Conversely, it does not make sense for a surplus country to continuously build up a stock of net claims on the rest of the world; eventually it will wish to spend those claims.