Open Economy Macroeconomics

This chapter presents the basic concepts of open economy macroeconomics. The first two sections discuss arbitrage-pricing models for goods and services in international trade and for interest rates in the capital flow between countries. The third section 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. The fourth section addresses the specification of the IS curve in an open economy, relating real output, the real interest rate, and the real exchange rate. The IS curve’s specifications are shown for the traditional and the new Keynesian models. The fifth section analyzes the determination of the long-run equilibrium real exchange rate, the natural exchange rate. The sixth section discusses the specification of the Taylor Rule in an open economy. The seventh section covers the specification of the Phillips curve in an open economy in the Keynesian and new Keynesian models.