soln3 - The real world interest rate must fall so the...

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Problem Set #3 Solutions Numerical Problem 5.2: The following table calculates key variables for this question for different values of the real interest rate. The column for S is calculated from the equation S = Y - (C d + G). The column headed by S - I is foreign lending. Absorption (A) is C d + I d + G. Net exports (NX) are output (Y) minus absorption (A). Every column except r consists of dollar amounts in billions. r C d I d S S - I A NX 5% 12 3 7 4 21 4 4% 13 4 6 2 23 2 3% 14 5 5 0 25 0 2% 15 6 4 -2 27 -2 Net exports and foreign lending are identical. Analytical Problem 5.5: In each case, suppose that both countries start out with a zero current account. a.) The Home country’s saving curve shifts to the right. The real world interest rate falls, so that the current account surplus in the home country equals the current account deficit in the foreign country. Therefore, S rises, I rises, r w falls. r w r w Home Country Foreign Country S, I S, I S d I d I d S d Home Home For For r r r w 0 1 0
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2 b.) The foreign country’s saving curve shifts to the right.
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Unformatted text preview: The real world interest rate must fall, so the current account surplus in the foreign country equals the current account deficit in the home country. Therefore, S falls, CA falls, r w falls. r w r w Home Country Foreign Country S, I S, I S d I d I d S d Home Home For For r r r w 1 c.) The foreign country’s saving curve shifts left. The real world interest rate must rise, so the current account deficit in the foreign country equals the current account surplus in the home country. Therefore, S rises, I falls, r w rises. r w r w Home Country Foreign Country S, I S, I S d I d I d S d Home Home For For r r r 1 w d.) If Ricardian equivalence holds, there is no effect. If Ricardian equivalence does not hold, then the result is the same as in part b, as the foreign country’s saving curve shifts to the right....
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soln3 - The real world interest rate must fall so the...

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