Chapter 11: OPEN ECONOMYMACROECONOMICS Economics 11-UPLB Prepared by Tirso B. Paris, Jr. September 25, 2007
Meaning of “Open Economy” Most modern economies do not operate in isolation. Countries rely in varying degrees on trade with other countries on goods and services for their consumption and production needs. The transactions among countries extend to transfer payments, sales and purchases of assets, borrowing and lending, etc. A country that engages in such transactions is called an open economy
Open Economy and BOP Open Economy - an economy that engages in transactions with other countries; the transactions involve goods and services, assets and transfers Balance of Payments (BOP) - a summary of the transactions between residents and non- residents of a country over a given period
Balance of Payments It records transactions in goods, services, assets and transfers. Government, financial institutions, and other economic agents refer to the BOP accounts in order to keep track of the countrys transactions with the rest of the world. The information helps them conduct analyses that could assist in the formulation of economic policies and decisions.
Table 11.1. BOP Acct of the Phil, 2002 (in million USD) Item Values Sub-totalsCurrent Account (CA) 4,197 Goods 408 Exports = 34383 Imports = -33975 Services and Income 3,286 Transfers (net) 503Capital Account (KA, net) -19Financial Account (FA) -2,085 Direct Investment (net 1,026 Portfolio Investment (net) 1,912 Other Investment (net) -5,023Net Errors & Omissions (NEO) -1,433CA + KA + FA + NEO 660Reserves and Related Assets (RRA) -660
Balance of Payments Account of the Philippines, 1997 (in million US dollars). Item Amount A. Current Account (CA) -4,303 Goods -11,127 Exports (FOB) 25,228 Impofts (FOB) -36,355 Services 1,015 Income 4,729 Transfers 1,080 B. Capital Account (KA) - C. Financial Account (FA) 6,357 Direct Investment 1,117 Portfolio investment 546 Other Investment 4,694 KA + FA 6,357 D. Net Errors and Omissions (NEO) -5,148 Sum of Items A to D -3,094 E. Reserves and Related Assets (RRA) 3,094Source: IMF. (1998), Balance pf Payments Statistics Yearbook
Current Account The Current Account reflects the flow of the countrys transactions in goods and services as well as current transfer payments. The inflows in this account are the earnings of residents from non-residents from goods and services, investments and current transfers. The outflows are the payments of residents to non-residents for the aforementioned transactions.
Capital Account Capital Account, the sum of the Capital Account and Financial Account represents capital transfers, changes in the resident claims on non-residents (changes in assets), and changes in non-resident claims on residents (changes in liabilities).
Financial Account The Financial Account captures transactions in equity and other financial assets. It is classified into Direct Investment represents transactions in equity capital, reinvested earnings, etc. Portfolio Investment represents transactions in equity securities and debt securities (bonds and notes, money market instruments, etc.). Other Investment (net) includes trade credits, short to long term loans, currency and other deposits
Reserves and Related Assets Reserves and Related Assets are composed of Exceptional Financing, Use of Fund Credit and Loans and Reserve Assets. Reserve Assets represent changes in the assets of the monetary authorities that can be used for balance of payments purposes. It is composed of Monetary Gold, Special Drawing Rights (SDR), Foreign Exchange and Other claims.
Net Errors and Omissions Theoretically, the sum of the Current Account, Capital Account, Financial Account and Reserves and Related Assets must be zero, i.e., CA+KA + FA + RRA = 0. The myriad of transactions between residents and non-residents poses difficulties for recording and compiling entries. These eventually cause the sum of the to be non-zero. To capture the presence of such a discrepancy, the practice is to present it as a separate item in the BOP accounts - Net Errors and Omissions.