DOE29 L5 - D0E29 - Theory of Economic Growth, Lecture 5...

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D0E29 - Theory of Economic Growth, Lecture 5 Spring semester 2008 Anna Salomons CES, KU Leuven Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 1 / 69
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Today&s class: The Solow model in a small open economy Introduction to the open economy Solow model Openness in the Solow model Solution to the open economy Solow model Implications of an open capital account Mock exam question about the basic±general Solow models = ) readings : Sorensen and Whitta-Jacobsen, chapter 4 Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 2 / 69
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Introduction to the Solow model in a small open economy Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 3 / 69
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Introduction to the open economy Solow model General equilibrium model Neoclassical growth model: no rigidities Basic Solow model: no technological progress Open economy: perfect capital mobility: real return on domestic capital equals real return on investment abroad perfect goods mobility: not relevant since each country is assumed to produce the same single good zero (international) labor mobility: this an empirically realistic assumption Model for a small economy: a small economy cannot in&uence the world interest rate Objective of the model: say something about the desirability of open capital markets Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 4 / 69
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Openness in the Solow model Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 5 / 69
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Openness and the Solow model In the basic Solow model, the economy is closed, and consequently, the only source of domestic investment is domestic saving. S ( t ) & I ( t ) = 0 This approximation is realistic when international capital &ows are relatively small However, the international mobility of capital &ows has increased greatly in recent decades. A country may ±nance part of domestic investment via capital imports, or invest part of domestic savings in capital exports. S ( t ) & I ( t ) = capital exports S ( t ) & I ( t ) can of course be negative (if a country imports capital). Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 6 / 69
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Foreign trade and foreign-owned assets relative to world GDP Trade volume= imports+exports Light columns illustrate degree of trade integration; dark columns illustrate degree of &nancial integration (or capital mobility) Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 7 / 69
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The Solow model and international capital mobility We disregard trade, and only look at international capital &ows International capital &ows consist of foreign direct investment (FDI) and international portfolio investment (PI), where the latter is the bigger &ow. What can the Solow model tell us about the desirability of free mobility of capital? Anna Salomons (CES, KU Leuven) D0E29 Lecture 5 12 March 2008 8 / 69
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Openness in the Solow model Let&s denote foreign assets, both FDI and PI, as F ( t ) , hence (disregarding capital depreciation δ ): ˙ F ( t ) + ˙ K ( t ) = S ( t ) where S ( t ) is domestic gross saving, F ( t ) is the stock of foreign assets, and K ( t ) is the.stock of domestic capital (i.e. equal to domestic investment) We can therefore rewrite this as ˙ F ( t ) = S ( t ) & I ( t )
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DOE29 L5 - D0E29 - Theory of Economic Growth, Lecture 5...

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