By Pablo Guerron-Quintana – Business Review, Federal Reserve Bank of Philadelphia
Countries, like families, incur deficits when expenditures exceed income. Countries around the world finance their deficits by issuing debt. This debt is bought by either domestic or foreign investors. The United States, Canada, Chile, Mexico, and South Korea are a few examples of countries that borrow in international markets. The difference between, say, the United States and Mexico is that the latter has little or no control over the premium it pays on its international debt.
In contrast, the price of debt issued by the United States depends to a large degree on its own characteristics, such as its domestic wealth, households’ preferences, and technology. This distinction between how much control a country has over the interest rate on its debt determines whether a country is called a small open economy. If, as in the case of Chile or South Korea, the price of debt is determined by international markets, then economists refer to these countries as small open economies. In the next few pages, the reader will be introduced to the main economic characteristics of this class of countries.
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Economics Small Open Economies
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