INTRODUCTION

When looking at the microeconomics of the open economy, we concentrated on the allocation of resources and distribution of income. We saw how international transactions affect the way an economy deals with the problems of efficiency and equity. When looking at the macroeconomics of the open economy, we will concentrate on the utilization of resources. We will see how international transactions affect the way an economy deals with the problem of stability. We will examine three issues:

• How international transactions affect output and price levels, money stocks, interest rates, and other variables important for macroeconomic theory and policy.

• How international transactions affect the freedom and effectiveness with which governments can use monetary and fiscal policies to achieve and maintain economic stability.

• How international monetary arrangements, especially exchange-rate arrangements, influence the answers to these questions.

These are complicated issues, and we will devote nine chapters to them.

Introducing International Transactions

How should international transactions be introduced into macroeconomic models? Can we merely add them to familiar closed-economy models, or must we reach deeply into those models to modify the basic behavioral relationships determining income, prices, and interest rates? For many years, economists opened up their models by adding international transactions, without reworking the basic behavioral relationships. But trade and other international transactions affect the domestic economy profoundly, even the U.S. economy, which is less open than many others. We cannot capture the effects of international transactions without revising our models completely.