Overview

International finance examines how nations interact through trade, capital flows, and currency markets. In an open economy, exports and imports, investment, and exchange rates influence overall economic performance. Understanding global linkages helps explain changes in output, inflation, and interest rates in a connected world.

Key Themes and Concepts

• Balance of Payments: Records a country's transactions with the rest of the world. Includes:
  • Current account: Net exports, income, and transfers
  • Financial account: Capital flows, investments, and reserves
• Trade Balance: Net exports (exports − imports). Trade surplus = positive balance; deficit = negative balance.
• Foreign Exchange Market: Determines currency values based on supply and demand. Currency appreciation reduces exports; depreciation boosts exports.
• Exchange Rate Systems: Floating vs. fixed exchange rates. Central banks may intervene in foreign exchange markets to stabilize or target rates.
• Factors Affecting Exchange Rates: Interest rates, inflation, trade flows, political stability, speculation, and capital movements.
• Capital Flows: Movement of financial capital between countries. Affects domestic interest rates, exchange rates, and investment.
• Policy Implications: Open economies must coordinate fiscal, monetary, and exchange rate policy. Balance of payments constraints can limit national policy choices.

Quick Tip

Trade and capital flows tie economies together. A strong currency can hurt exports, while capital inflows may boost investment but raise interest rates. Understanding exchange rates and the balance of payments helps explain how global shocks affect domestic economies.