## The Open Economy: International Capital Flows and the Trade Balance

In an open economy (as well as a closed economy) financial markets and goods markets are closely related. To see the relationship, we must rewrite the national income accounts identity in terms of savings and investment. We subtract C and G from both sides to leave us with

Y – C – G = I + NX

Recall that Y- C – G is national savings S (the sum of private savings, Y – T – C, and public savings, T – G, where T stands for tax).

Therefore,

S = I - NX

Subtracting I from both sides results in

S – I = NX

This form of the national income accounts identity shows that an economy’s net exports must always equal the difference between its savings and its investment.

The below video describes the derivation of the above equations as well as explaining the relationship between International Capital Flows and the Trade Balance.

Y – C – G = I + NX

Recall that Y- C – G is national savings S (the sum of private savings, Y – T – C, and public savings, T – G, where T stands for tax).

Therefore,

S = I - NX

Subtracting I from both sides results in

S – I = NX

This form of the national income accounts identity shows that an economy’s net exports must always equal the difference between its savings and its investment.

The below video describes the derivation of the above equations as well as explaining the relationship between International Capital Flows and the Trade Balance.