Chapter 17
Open-Economy Macroeconomics
This chapter develops the IS–LM–BP analysis to describe the determination of equilibrium income and
interest rate. Students who have not had intermediate macroeconomics will find this material difficult.
A good drill to aid their understanding is to draw an equilibrium IS–LM–BP diagram and then place points
away from equilibrium that the students must describe. They will soon begin to think in terms of excess
demands and supplies and of incomes and interest rates “too high” or “too low” for equilibrium.
The bottom line of the analysis is the usefulness of the apparatus for policy discussions. A good drill is to
require the students to illustrate and explain alternative policy effects.
◼ Chapter Outline
Introduction
Modeling the Macroeconomy
Internal and External Balance
International Policy Coordination
Global Insights 17.1: The Plaza Agreement
Global Insights 17.2: The G20
Summary
Exercises
Appendix 17.1
The Mundell-Fleming Model
The IS Curve
The LM Curve
The BP Curve
Equilibrium
Monetary Policy under Fixed Exchange Rates
Chapter 17 Open-Economy Macroeconomics 83
◼ Suggested Answers for the End-of-Chapter Exercises
1. Define internal and external balance and give an example of how the pursuit of one might cause
a problem in achieving the other.
An internal balance is a rate of domestic economic growth consistent with a low unemployment rate,
2. How does a coordinated intervention policy help bring about a convergence of macroeconomic
policies?
3. Suppose that the U.S. Congress imposes an increase in taxes. Use the simple macromodel developed
in the chapter to predict the impact of this policy on output and the current account balance.
An increase in taxes, all other things constant, reduces spending on domestic goods and so leads to a
4. Suppose that China allows its currency to float and its exports to the United States fall significantly.
How would this impact Chinese output level and its current account balance? Identify an alternative
policy that it might pursue to get output back to its initial level. What impact would this policy have
on its current account balance?
5. Assume that the marginal propensity to save is 0.4 and the marginal propensity to import is 0.2.
Calculate the change in the equilibrium level of national income if investment spending declines
by $10 million. What is the size of the open-economy multiplier?
6. Use the Swan diagram to show and identify the appropriate policy choices for a country experiencing
an inflationary boom and a current account deficit. What Zone is the economy in? What policies
should the country undertake? Would the policy combination be the same anywhere in the Zone?
Why or why not?
7. Let us characterize an economy as follows:
s = 0 .15 Io = 400 Go=TXo=IMo= 0
m = 0 .05 EXo = 600
i. Find the value of the open economy multiplier.
ii. What is the equilibrium level of GDP for this economy?
iii. Suppose that exports were to rise by 200, what would happen to the equilibrium level of GDP?
Explain.
iv. Suppose instead that due to a tariff, there was a switch of 500 in purchases of imports to an
Chapter 17 Open-Economy Macroeconomics 85
equivalent increase in I. What would be the effect on GDP? Explain.
8. Consider the following economy:
s= 0.2 m= 0.2 Io=500 Go=250 TXo=200 EXo=400
i. Find the value of the open economy multiplier.
ii. What is the equilibrium level of GDP for this economy?
iii. What is the initial current account balance for this country?
iv. Suppose that government spending falls by 50. What will happen to the equilibrium level of
GDP? What will happen to the current account balance?
v. Beginning at the initial equilibrium point, suppose instead that exports rise by 50. What will
happen to the equilibrium level of GDP? What will happen to the current account balance?
86 Husted/Melvin • International Economics, Ninth Edition
9. Consider a devaluation that raises EX0 to EX1 and lowers autonomous import expenditures from IM0
to IM1. Draw a graph that shows the impact of these changes on the equilibrium level of output and
the current account balance.
10. Consider the economy described in question 9. Use the algebra of the model to calculate changes in Y
and the CAB brought on by the devaluation.
As a result of the devaluation, exports will increase and Y will increase by an amount equal to: