The Open Economy: Global Economic Integration
The Open Economy
The External Sector
Introduction
Global Economic Integration through:
– (1) Opening up international trade in goods and services
– (2) Opening up international movement of labour
– (3) Opening up international movement of capital
Macroeconomic policy focuses on (1) and (3)
In a globally integrated world, macroeconomic policies of a country have repercussions on other economies too
Introduction
The extent of these repercussions depends on
– (a) size of international trade in a country’s GDP,
– (b) how mobile is the capital between the countries, and – (c) the exchange rate regime
Discussion
– Different exchange rate regimes – External balance of payments account – Open economy macroeconomic policy issues
Exchange Rates
Exchange rate is the price of one (domestic) currency in relation to another (foreign) currency
The market where the various currencies are traded is called the foreign exchange market
Determinants of Exchange Rates
1) Interest rates: determines the attractiveness of a country as an investment avenue Higher the investment inflow, higher the value of the domestic currency
2)Price levels: high inflation rate means lower the purchasing power of the currency and lower the value of currency
3) Growth rate: High growth rate attracts more foreign investment and improves the value of the currency 4) Other economic factors: like fiscal deficit, competitiveness of a country’s exports, etc.
Types of Exchange Rates (Regimes)
The main exchange rate regimes are three:
(a) Flexible (or floating) exchange rate: the value of domestic currency in relation to the foreign currency is determined based on demand for and supply of currencies.
(b) Fixed exchange rate: the value of a currency is fixed in terms of other currencies (by the Central Bank) and does not change according to demand and supply (c) Managed float is a combination of fixed and flexible exchange rate
The External Sector
Introduction
Global Economic Integration through:
– (1) Opening up international trade in goods and services
– (2) Opening up international movement of labour
– (3) Opening up international movement of capital
Macroeconomic policy focuses on (1) and (3)
In a globally integrated world, macroeconomic policies of a country have repercussions on other economies too
Introduction
The extent of these repercussions depends on
– (a) size of international trade in a country’s GDP,
– (b) how mobile is the capital between the countries, and – (c) the exchange rate regime
Discussion
– Different exchange rate regimes – External balance of payments account – Open economy macroeconomic policy issues
Exchange Rates
Exchange rate is the price of one (domestic) currency in relation to another (foreign) currency
The market where the various currencies are traded is called the foreign exchange market
Determinants of Exchange Rates
1) Interest rates: determines the attractiveness of a country as an investment avenue Higher the investment inflow, higher the value of the domestic currency
2)Price levels: high inflation rate means lower the purchasing power of the currency and lower the value of currency
3) Growth rate: High growth rate attracts more foreign investment and improves the value of the currency 4) Other economic factors: like fiscal deficit, competitiveness of a country’s exports, etc.
Types of Exchange Rates (Regimes)
The main exchange rate regimes are three:
(a) Flexible (or floating) exchange rate: the value of domestic currency in relation to the foreign currency is determined based on demand for and supply of currencies.
(b) Fixed exchange rate: the value of a currency is fixed in terms of other currencies (by the Central Bank) and does not change according to demand and supply (c) Managed float is a combination of fixed and flexible exchange rate
References: 1. Chapters 6,‘Principles of Macroeconomics’, 8th edn. by Michael Melvin and William Boyes. Chapters 6, ‘Macroeconomic Policy Environment’ by Shymal Roy 2.