Open Economy Macroeconomics

Abstract

This chapter presents the basic concepts of open economy macroeconomics. Sections 8.1 and 8.2 discuss arbitrage-pricing models for goods and services in international trade and for interest rates in the capital flow between countries. Section 8.3 introduces the Marshall-Lerner condition, which sets a condition for a positive correlation between the terms of trade and the current account on the balance of payments. Section 8.4 addresses the specification of the IS curve in an open economy; showing the relationship between real output, real interest rate, and real exchange rate. The specifications of the IS curves are shown for the traditional and the new Keynesian models. Section 8.5 analyzes the determination of the long-term equilibrium real exchange rate, the natural exchange rate. Section 8.6 discusses the specification of the Taylor Rule in an open economy. Section 8.7 covers the specification of the Phillips curve in an open economy in the Keynesian and new Keynesian models.