Chapter 31: The Macroeconomics of Open Market Operations

Chapter 31 talks about the macroeconomics in open economies. Part of these include the market of loanable funds and the market of currency exchanges. Furthermore, trade policy and budget deficits are taken into account.

The two markets central to the macroeconomics of open economies are the market for loanable funds and the market for foreign currency exchange. In the market for loanable funds, the interest rate changes to balance the supply of funds and the demand for funds, coming from national saving and investment, respectively. In the market for foreign currency exchange, the real exchange rate adjusts to balance the supply and demand for dollars. Since net foreign investment is part of the demand for loanable funds and provides the supply of dollars for exchange, it is the variable connecting the two markets.

Trade policies could help reduce national saving. Policies like this, such as government budget deficits, reduce the supply of loanable funds, increasing the interest rate. The higher the interest rate, the lower the net foreign investment, reducing the supply of dollars in the market for foreign currency exchange. The dollar gains values, and exports fall.

Restrictive trade policies such as tariffs or import quotas are shown to alter the trade balance, but do not always have that effect. Trade restrictions increase net exports and demand for dollars in the market for foreign currency exchange. Therefore, the dollar gains more value, making domestically produced goods more expensive. However, the increase in value offsets the impact of trade restriction on net exports.