ABSTRACT

Globalization has raised awareness among millions of people of the forces unleashed when an economy is opened up to trade and world capital markets. No survey of macroeconomic theory completes without coverage of open economy macroeconomics. There are two pure systems for setting exchange rates. Under fixed exchange rates, the central bank posts the price at which it is willing to buy or sell foreign currencies, and tries to maintain those rates administratively. Under a flexible or floating exchange rate system, rates are established in the private markets for foreign currencies, which central banks may influence but do not control. In practice, many arrangements fall between these two extremes. Between the extremes of zero and perfect capital mobility, distinguishes between relatively immobile capital, when the BP curve is steeper than the LM curve, and relatively mobile capital, when the LM curve is steeper than the BP curve. These distinctions prove the effects of fiscal policy in the open economy.