Is the us a small economy economy 44 capital market

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Unformatted text preview: equals the world interest rate (rw). (Why?) A small economy takes the world interest rate as given • How is the world interest rate determined? Is the US a “small economy”? economy” 44 Capital Market (cnt.) cnt.) • The Cap.A (and therefore CA) is determined by the Cap.A CA difference between saving and investment at the world interest rate world Depending on the domestic S and I curves and the prevailing world interest rate, an economy can have a zero, positive, or negative trade balance • Some applications: Is a larger trade deficit necessarily bad? Suppose the investment opportunities in an economy expand. The investment curve shifts outward and the deficit worsens. (A leftward shift in S has the same effect) 45 Capital Markets (cnt.) cnt.) • More applications: Does a budget deficit lead to a trade deficit? In the 80s both deficits were high leading to theories that the twin deficits were connected. In the traditional view, a budget deficit financed by tax cut decreases saving, which in turn worsens the trade deficit Note, the Ricardian argument against this view – there, the national saving is unchanged and so is the trade deficit An increase in the world interest rate (say due to a decrease in funds supplied to the market by some large economies) will cause a decrease in the trade deficit of a small open economy 46 10 10 Glossary S I TR T G INT I NX CA Saving Investment Government transfers Taxes Government expenditures (purchases) Net interest & dividend payments received from abroad Investment Net exports Current Account 47 THE END 48 11 11...
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