{"id":21542,"date":"2012-11-02T19:26:29","date_gmt":"2012-11-02T09:26:29","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=21542"},"modified":"2012-11-02T19:26:29","modified_gmt":"2012-11-02T09:26:29","slug":"external-economy-considerations-part-1","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=21542","title":{"rendered":"External economy considerations – Part 1"},"content":{"rendered":"

\t\t\t\tI am now using Friday’s blog space to provide draft versions of the Modern Monetary Theory textbook that I am writing with my colleague and friend Randy Wray. We expect to complete the text by the end of this year. Comments are always welcome. Remember this is a textbook aimed at undergraduate students and so the writing will be different from my usual blog free-for-all. Note also that the text I post is just the work I am doing by way of the first draft so the material posted will not represent the complete text. Further it will change once the two of us have edited it.
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\nChapter 15 International Trade, Capital Flows and the Exchange Rate<\/strong><\/p>\n

[Note: This is the first rough layout and will evolve over the next few weeks]<\/p>\n

15.1 Introduction<\/strong><\/p>\n

In Chapter 8, we introduced trade into the income-expenditure model. The representation was simplistic, in the sense, that we assumed that exports were determined by the income levels prevailing in the rest of the world (that is, they were exogenous to the domestic economy) and that imports were a simple proportion of the national income of the homeeconomy. This proportion was termed the marginal propensity to import.<\/p>\n

In this Chapter we extend our understanding of the way in which the economy behaves once it becomes open to the World. We will continue to consider the price level to be fixed, which means we are assuming that firms respond to an increase in aggregate demand by increasing real output. Later in the Chapter we will consider price level movements in the open economy context.<\/p>\n

We will the consider the concept of an exchange rate and examine how movements in exchange rates influence exports and imports and financial transactions between nations.<\/p>\n

For an economy as a whole, imports are real goods and services coming into the nation from abroad and as such represent a real benefit to residents. Conversely, exports are real goods and services that are sold to foreigners.<\/p>\n

Exports represent a real cost to residents because they represent real resources (labour, capital and other productive inputs) that the residents are unable to utilise themselves.<\/p>\n

It is obvious that the only motivation for a nation to export, and incur the real costs involved in exporting goods and services abroad, is to gain foreign currencies, which, in turn, allow the nation to purchase other goods and services that it does not produce itself. <\/p>\n

If imports exceed exports then a nation is able enjoy higher material living standard by consuming more goods and services than it produces for foreign consumption. We will consider how this conception of trade interacts with a flexible exchange rate.<\/p>\n

You will already appreciate that the transactions between nations involve both real goods and services and financial flows. The financial transactions represents currency flows in and out of a nation and have significant implications for movements in the exchange rate and other macroeconomic aggregates, such as interest rates, the inflation rate and real GDP.<\/p>\n

All transactions between a nation and the rest of the world are recorded in the Balance of Payments. We will initially examine the way the national statistician accounts for the external economy via the Balance of Payments, which is a framework that is closely related to the National Accounts.<\/p>\n

15.2 The Balance of Payments<\/strong><\/p>\n

National Statistical agencies regularly publish statistics relating to a nation’s economic interaction with the rest of the world using what is known as the balance of payments and international investment position framework. While there are variations in terminology used by different nations the principles are universal. Most nations use the International Monetary Funds’s http:\/\/www.imf.org\/external\/pubs\/ft\/bop\/2007\/pdf\/bpm6.pdf (BPM6)<\/a>, augmented by the System of National Accounts 2008 (2008 SNA)<\/em>, “as the standard framework for statistics on the transactions and positions between an economy and the rest of the world” (IMF, 2011: 1).<\/p>\n

The IMF define the balance of payments as:<\/p>\n

\n… a statistical statement that summarizes transactions between residents and nonresidents during a period. It consists of the goods and services account, the primary income account, the secondary income account, the capital account, and the financial account.\n<\/p><\/blockquote>\n

The differentiating feature of these difference accounts relates to “the nature of the economic resources provided and received” by the nation (IMF, 2011: 9).<\/p>\n

The Current Account<\/strong> (IMF, 2011: 9):<\/p>\n

\n… shows flows of goods, services, primary income, and secondary income between residents and nonresidents.\n<\/p><\/blockquote>\n

The goods and services or balance of trade<\/strong> records “transactions in items that are outcomes of production activities” (IMF, 2011: 149) and considers the exchanges between the local economy and the rest of the world.<\/p>\n

[NOTE THIS SECTION IS TO BE WRITTEN AND IS DESCRIPTIVE – IT OUTLINES THE BALANCE OF PAYMENTS AND RELATED INTERNATIONAL ACCOUNTS]<\/p>\n

15.3 Essential concepts<\/strong><\/p>\n

Before we consider a more complex income and expenditure model (to incorporate exchange rates) we need to understand the basic nomenclature.<\/p>\n

The following essential concepts are used in open economy macroeconomics:<\/p>\n