Open economy macroeconomics examines how the economy is affected by links with other countries through trade, the exchange rate, and capital flows.

Capital controls are regulations preventing private sector capital flows.

Unsterilized intervention uses the forex reserves to offset payments imbalances, consequently changing the domestic money supply.

Sterilization is an open market operation between domestic money and domestic bonds, to offset the change in domestic money supply that a balance of payments surplus or deficit otherwise induces.

Sterilized intervention does not work when there is perfect capital mobility, because offsetting capital flows are immediately induced.

Perfect capital mobility undermines monetary sovereignty. If interest rates are set to maintain the pegged exchange rate, they cannot be set independently to influence the domestic economy.

A Tobin tax is a small tax on capital flow transactions.

The par value is the exchange rate that the government agrees to defend.

A devaluation (revaluation) reduces (increases) the par value of the pegged exchange rate.

With floating exchange rates, monetary sovereignty is restored even under perfect capital mobility. The central bank sets the interest rate and accepts the exchange rate determined by market forces.

The purchasing power parity (PPP) path of the nominal exchange rate is the path that offsets differential inflation rates across countries, maintaining a constant real exchange rate.

Floating exchange rates are volatile because they are asset prices that reflect beliefs about the entire future. Such beliefs can change a lot.

When new information becomes available, asset prices jump to the level that now properly reflects the new information.