19.3 How Policies and Events Affect an Open Economy

19.3 a. Government Budget Deficits

A budget deficit occurs when expenditures exceed revenue, and it is an indicator of financial health [9]. Because a government deficit represents negative public saving, it lowers national saving. This leads to a decline in the supply of loanable funds [2].

Example: During the First World War, governments borrowed heavily and depleted financial reserves to finance the war and their growth [9].

^{Budget Deficits [11]}

19.3 b. Trade Policy

Laws related to the exchange of goods or services involved in international trade including taxes, subsidies, and import/export regulations [10].

Example: Adding more tariffs to trade imports from China [10].

^{Real Exchange Rate [16]}

19.3 c. Political Instability and Capital Flight

Capital flight is a large-scale exodus of financial assets and capital from a nation due to events such as political or economic instability, currency devaluation or the imposition of capital controls. Capital flight often occurs because investors feel that the country is unstable, due to either economic or political problems [13].

Example: The International Monetary Fund estimates that citizens of developing countries amassed about $250 billion worth of foreign assets between 1975 and 1985 (compared to a total foreign debt of $800 billion). Although Mexico had the largest dollar total ($40 to $50 billion), Venezuela’s and Argentina’s holdings were a larger proportion of national income (nearly equal to their debt) [14].

^{China’s Capital Flight [15]}