Chapter 11: OPEN ECONOMY MACROECONOMICS

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Chapter 11 OPEN ECONOMY MACROECONOMICS

• Economics 11-UPLB
• Prepared by Tirso B. Paris, Jr.
• September 25, 2007

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Meaning of Open Economy

• Most modern economies do not operate in
  isolation.
• Countries rely in varying degrees on trade with
  other countries on goods and services for their
  consumption and production needs.
• The transactions among countries extend to
  transfer payments, sales and purchases of assets,
  borrowing and lending, etc.
• A country that engages in such transactions is
  called an open economy

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Open Economy and BOP

• Open Economy - an economy that engages in
  transactions with other countries the
  transactions involve goods and services, assets
  and transfers
• Balance of Payments (BOP) - a summary of the
  transactions between residents and non-residents
  of a country over a given period

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Balance of Payments

• It records transactions in goods, services,
  assets and transfers.
• Government, financial institutions, and other
  economic agents refer to the BOP accounts in
  order to keep track of the country's transactions
  with the rest of the world.
• The information helps them conduct analyses that
  could assist in the formulation of economic
  policies and decisions.

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Table 11.1. BOP Acct of the Phil, 2002 (in
million USD)
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Source IMF. (1998), Balance pf Payments
Statistics Yearbook
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Current Account

• The Current Account reflects the flow of the
  country's transactions in goods and services as
  well as current transfer payments.
• The inflows in this account are the earnings of
  residents from non-residents from goods and
  services, investments and current transfers.
• The outflows are the payments of residents to
  non-residents for the aforementioned
  transactions.

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Capital Account

• Capital Account, the sum of the Capital Account
  and Financial Account represents capital
  transfers, changes in the resident claims on
  non-residents (changes in assets), and changes in
  non-resident claims on residents (changes in
  liabilities).

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Financial Account

• The Financial Account captures transactions in
  equity and other financial assets.
• It is classified into
• Direct Investment represents transactions in
  equity capital, reinvested earnings, etc.
• Portfolio Investment represents transactions in
  equity securities and debt securities (bonds and
  notes, money market instruments, etc.).
• Other Investment (net) includes trade credits,
  short to long term loans, currency and other
  deposits

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Reserves and Related Assets

• Reserves and Related Assets are composed of
  Exceptional Financing, Use of Fund Credit and
  Loans and Reserve Assets.
• Reserve Assets represent changes in the assets of
  the monetary authorities that can be used for
  balance of payments purposes. It is composed of
  Monetary Gold, Special Drawing Rights (SDR),
  Foreign Exchange and Other claims.

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Net Errors and Omissions

• Theoretically, the sum of the Current Account,
  Capital Account, Financial Account and Reserves
  and Related Assets must be zero, i.e., CAKA
  FA RRA 0.
• The myriad of transactions between residents and
  non-residents poses difficulties for recording
  and compiling entries. These eventually cause the
  sum of the to be non-zero.
• To capture the presence of such a discrepancy,
  the practice is to present it as a separate item
  in the BOP accounts - Net Errors and Omissions.

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End Chapter 11