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Unformatted text preview: Extra Credit answer key: Ch. 5 4. In Figure 5.4, suppose initially that both countries have a zero current account. A rise in the government budget deficit has no effect on desired investment, so it affects the current account only if it affects desired national saving. If desired national saving is affected, the saving curve shifts to the left from S 1 to S 2 . This raises the world real interest rate, reduces investment in both countries, and increases the foreign country’s current account balance. Figure 5.4 6. A temporary adverse supply shock hitting the foreign economy causes the foreign saving curve to shift to the left, from 1 For S to 2 For S in Figure 5.7. This raises the equilibrium world real interest rate, increasing home country saving and decreasing home country investment. Since saving rises and investment falls, the home country’s current account balance increases. Chapter 5 Saving and Investment in the Open Economy 111 Now consider a worldwide temporary adverse productivity shock, which causes both the saving curve...
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