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Chapter 12 The Balance of Payments and the Exchange Rate

Chapter 12 The Balance of Payments and the Exchange Rate In today's global economy world, the phenomenon of the "closed economy" one that is unaffected by international trade and capital flows is little more than an abstract textbook concept. The notion of a closed economy is nevertheless quite useful in intermediate macroeconomics, as it allows for the analysis of the fundamental aspects of the economy ( the impact of monetary and fiscal policy) without considering the complicating effects of globalization. With the fundamentals well understood, however, we can now provide more realism by looking at the open economy that is directly affected by global marketplace. Considering an economy as part of the global marketplace adds complexity to our model. The first bit of complexity comes in form of new terminology and concepts. We shall start by introducing the two fundamental concepts of the open economy: the Balance of Payments (BoP) and the Exchange rate.

The balance of payments (BoP) is the international balance sheet of a nation that records all international transactions in goods, services, and assets over a year. That is why this BoP is usually under the International Transactions Accounts in national statistical data. The BoP is that of a simple accounting tool,

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