06b - Chapter 6 THE OPEN ECONOMY(PART B WUKUANG CUN Outline saving and investment(the loanable funds market in a small Open economy National saving The

06b - Chapter 6 THE OPEN ECONOMY(PART B WUKUANG CUN Outline...

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Unformatted text preview: 2/28/2015 Chapter 6 THE OPEN ECONOMY (PART B) WUKUANG CUN Outline - saving and investment (the loanable funds market) in a small Open economy 2/28/2015 National saving: The supply of loanable funds I” §=F—C(7—?)—E As in Chapter 3, national saving does not depend on the interest rate Assumptions about capital flows a. domestic & foreign deposits/bonds are perfect substitutes (same risk, maturity, etc.) b. perfect capital mobility: no restrictions on international trade in assets c. economy is small: cannot affect the world interest rate, denoted r* a &b implyr=r* c implies r* is exogenous Investment: The demand for loanable funds I‘ Investment is still a downward-sloping function of the interest rate, but the exogenous world interest rate... ...determines the country’s level of [(r) Investment. If the economy were closed... I' ...the interest rate would adjust to equate investment and saving: I‘c 2/28/2015 2/28/2015 But in a small open economy... the exogenous world interest rate determines investment... ...and the difference between saving and investment determines net capital outflow and net exports Next, three experiments: 1. Fiscal policy at home 2. Fiscal policy abroad 3. An increase in investment demand (exercise) 2/28/2015 1. Fiscal policy at home I' An increase in G or decrease in T reduces saving. Results: AI = 0 ANX=A$<0 NX and the federal budget deficit (% ofGDP), 1965—2013 10% Budget deficit 8% 6%— 4%- 2%- 0%- / Qty _ Net exports ° (right scale) -4% i i i i i i i i i 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2/28/2015 2. Fiscal policy abroad Expansionary fiscal policy abroad raises the world interest rate. Results: AI < 0 ANX 2 —AI > O NOW YOU TRY Use the model to determine the impact of an increase in investment demand on NX, S, I, and net capital outflow. 2/28/2015 ANSWERS AI > 0, A5 = 0, net capital outflow and NX fall by the amount AI Example 6.2 (1) Y = 5 (2)G=1andT=1 (3) C = 0.5(Y-T) (4) I = 5 — 100r Q1: Assuming the economy is closed (Chapter 3 model), solve for the equilibrium interest rate. Q2: Assuming the economy is open (Chapter 6 model), r* = 0.04, solve for NX ? 2/28/2015 Example 6.2 (1) Y: 5 (2)G=1andT=1 (3) C = 0.5(Y-T) (4) I = 5—100r Ql: Assuming the economy is closed (Chapter 3 model), solve for the equilibrium interest rate. a.C=0.5(5-1)=2 b.SH=(Y-T)—C=2,SG=T—G=0,S=2 c.|=59 2=5—100r9r=0.03=3% Example 6.2 (1) Y = 5 (2)G=1andT=1 (3) C = 0.5(Y-T) (4) I = 5 — 100r Q2: Assuming the economy is open (Chapter 6 model), r* = 0.04, solve for NX ? a. |nQ1,S=2 b.|=5—100r*=1 c.NX=S—|=1 Example 6.3 (1) We are living in a small open economy. (2) All the foreign economies starts to increases government spending. Q1: what happens to the world interest rate r*? Q2: what happens to the domestic investment ? Q3: what happens to the net exports? Example 6.3 (1) We are living in a small open economy. (2) All the foreign economies starts to increases government spending. Q1: what happens to the world interest rate r*? Note: when we look the world economy as a whole, it is a closed economy...use the model in Chapter 3! Thus, G T 9 S shifts to the left 9 r* T 2/28/2015 Example 6.3 (1) We are living in a small open economy. (2) All the foreign economies starts to increases government spending. Q2: what happens to the domestic investment ? r* T 9 | l Example 6.3 (1) We are living in a small open economy. (2) All the foreign economies starts to increases government spending. Q3: what happens to the net exports? ll 9 NXT 2/28/2015 10 ...
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