[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

The Basic Trade Identity
The capital market balances saving and investment. In doing so it balances leakages
and injections from the spending stream, ensuring that aggregate spending
equals potential GDP at full employment. In Chapter 25, we showed that this equation
remains valid when the government is added to the basic full-employment model.
The same continues to hold true for an open economy. Reexamining the connection
between capital market equilibrium and aggregate spending in an open economy,
we find an important relationship between net capital flows and the balance between
exports and imports.
When the capital market is in equilibrium, investment equals private saving (S p )
plus government saving (S g ) plus net capital inflows:
S p + S g + NCF = I.
Private saving is income minus consumption and taxes: S p = Y − C − T. Government
saving is T − G, where G represents government purchases. Thus capital market
equilibrium implies
(Y − C − T) + (T − G) + NCF = Y − C − G + NCF = I.
When an economy engages in international trade, there are four sources of aggregate
demand: consumption, investment, government purchases, and net exports (NX).
Net exports are equal to exports minus imports. In an economy in equilibrium, these
four sources of demand must add up to the total output being produced:
Y = C + I + G + NX.
If we substitute this into the previous equation to eliminate Y, we find that
I + NX + NCF = I.
Subtracting investment (I) from both sides gives us our key result:
NX + NCF = 0.
That is, net exports (NX ) plus net capital inflows (NCF) equal zero. If net capital
flows are positive, net exports must be negative (imports exceed exports). When
net exports are negative, we say the country has a trade deficit. If net capital flows
are negative, net exports must be positive and the country has a trade surplus.
The United States has a large net capital inflow and net exports are negative.
The large net capital inflow into the United States and the large U.S. trade deficit are
not separate phenomena. A country like Japan that lends more aboard than it
borrows has a negative net capital inflow and its net exports are positive.
To understand better the relationship between foreign borrowing and the trade
deficit, let’s trace what happens when an American buys a German car. It appears
572 ∂ CHAPTER 26 THE OPEN ECONOMY AT FULL EMPLOYMENT