Open economy

An open economy is defined as an economy that exchanges goods and services or financial assets with the rest of the world. The exchange of goods and services takes place through imports (purchases from abroad) and exports (sales abroad). The difference between exports and imports, so-called net exports, gives the size of the trade balance. A country whose exports exceed imports is in surplus vis-à-vis the rest of the world, and vice versa, while a country whose imports exceed exports must simultaneously borrow from the rest of the world on capital account in order to finance the trade deficit.

The dynamics of the external accounts determines and is determined by, among other things, the real exchange rate, which depends on trends in the nominal exchange rate, that is, the relative price of currencies between countries, and relative trends in inflation. Inflation can be defined in terms of indices of consumer prices, producer prices, export prices or unit labor costs. The latter is the most significant inflation indicator for price-competitiveness purposes. An appreciation of the real exchange rate can generate a worsening of the trade balance: if foreign goods become cheaper than domestic goods, there is a shift in demand that causes imports to increase and exports to decrease, thus generating a worsening of the balance.

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