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Chapter Review Chapter 8: The Open Economy at Full Employment

  1. In an open economy, investment can be financed from domestic national saving or borrowing from abroad.
  2. In a small open economy, changes in national saving will not affect the international real interest rate or the level of domestic investment. Changes in national saving will affect the level of net capital inflows.
  3. In a large open economy such as the United States’, a fall in national saving will raise the real interest rate. This rise attracts net capital inflows and moderates the decline in domestic investment.
  4. The basic trade identity states that net exports plus net capital inflows equal zero. A trade deficit must equal net capital inflows; a trade surplus must equal capital outflows.
  5. Changes in the exchange rate ensure that net exports move in tandem with net capital flows.
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