ABSTRACT

The second half of this book has thus far dealt almost entirely with the balance of payments and with exchange markets. It is now necessary to turn to the effects of international trade and capital flows on the behavior of a domestic macroeconomy, with particular emphasis on business cycles and on the usefulness of monetary and fiscal policies in dealing with them. This chapter will first add international trade to a typical Keynesian national income determination model to see how such trade affects the cyclical behavior of the economy. It turns out that the effects are sizable, particularly for an economy that is relatively open to trade, that is, for a country in which exports and imports play a large role. Macroeconomic shocks that originate within the economy are somewhat milder, because the Keynesian multiplier is smaller, but business cycles are transmitted from one economy to another through trade flows. Although this Keynesian approach might reasonably be viewed as oversimplified, it is surprisingly useful in understanding real-world macroeconomic events.