Topic14_A_BOP_AAP

Loses foreign reserves can precipitate a gov crisis

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Unformatted text preview: s It depends on the FX regime FX If floating it may imply a future depreciation of the FX rate FX If fixed, gov. loses foreign reserves, can precipitate a gov. crisis Are deficits bad? 35 Open Economy Accounting • In a closed economy, Y=C+I+G • In an open economy, the national income identity is Y = C + I + G + NX NX where NX is net exports (exports – imports of G&S) NX 36 7 7 Open Economy Accounting (cnt.) cnt.) • Total income is spent: Y + TR + INT = C + T + Sp where: TR INT TR is government transfers INT is net interest received (+) T is tax paid Sp is private savings 37 Open Economy Accounting (cnt.) cnt.) • Combine the two relations by substituting out Y: C + Sp + (T - TR) - INT = C + I + G + NX NX • Eliminate C and rearrange to get a very important identity Analysts often ignore this when they discuss economic policy 38 Open Economy Accounting (cnt.) cnt.) • Combine the two relations by eliminating Y: C + Sp + (T - TR) - INT = C + I + G + NX NX • Eliminate C and rearrange to get a very important identity identity Analysts often ignore this when they discuss economic policy S p I G TR T NX INT Priv. Inv. Savings Budget Deficit CA Surplus 39 8 8 Open Economy Accounting (concl.) concl.) • Combine private & government savings and rearrange to get Snatl = I + CA CA where Snatl is “national savings” savings” 40 OE Accounting Example • Let Sp = 600, I = 800, Gov. Deficit = 100. Gov. What does CA have to be? CA Snat’l = I + CA CA nat’ 41 Capital Market in an Open Economy • In a closed economy, the capital market equilibrium is just Sd = I d • The home supply of loanable funds has to equal the home demand for loanable funds, and the home interest rate adjusts to clear the capital market • In an open economy, the country as a whole can borrow if its citizens do not save enough to meet domestic investment demand. Sd could be less than Id, and CA could be negative CA (exports < imports) Sd - Id = CA CA 43 9 9 Capital Market (cnt.) cnt.) • In a small open economy it follows that the open domestic interest rate...
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