Chapter 11: OPEN

ECONOMY
MACROECONOMICS
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 country's 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-totals
Current Account (CA) 4,197
Goods 408
Exports = 34383
Imports = -33975
Services and Income 3,286
Transfers (net) 503
Capital Account (KA, net) -19
Financial Account (FA) -2,085
Direct Investment (net 1,026
Portfolio Investment (net) 1,912
Other Investment (net) -5,023
Net Errors & Omissions (NEO) -1,433
CA + KA + FA + NEO 660
Reserves 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) 3,094

Source: IMF. (1998), Balance pf Payments Statistics Yearbook

 Current Account
The Current Account reflects the flow of
the country's 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.
End Chapter 11