The Policy Mix in the Open Economy

In the preceding chapters we have considered the principles on which decisions should be made about the best policy mix to minimise inflation whilst maintaining a high level of activity, within the context of a closed economy. This economy may be thought of as the world as a whole, or as a first approximation to the relevant prescription for an individual country, especially a large one. But we have now to ask how the analysis has to be modified to take into account the qualifications and complications that arise when the country whose policy decisions we are considering has transactions with countries in the outside world, the governments of which it cannot control and which it will usually not be able to influence to any appreciable extent. A very large country may reasonably feel it appropriate to assume that its own actions influence the actions of other governments to some extent, and that its actions have an appreciable effect on economic events in the outside world; and also that these outside actions and events then react back on itself. The greater the extent to which it needs to take account of such repercussions as these, the closer will its position be to that of a closed economy; and the less need will there be to qualify the analysis of the preceding chapters. But most countries (probably all countries apart from the USA, and in some contexts West Germany and Japan) have to be regarded as ‘small’ in the sense that their policy decisions will not normally have an appreciable effect on the rest of the world; or not to such an extent that any repercussions will then react back on them in a manner that normally needs to be taken into account in forming their policies. It is the policies of ‘small’ countries in this sense that are beine discussed in this chapter.1