IFI Homework 1 - Homework 1 Question 1 In other terms...

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Homework 1 Question 1 In other terms, Thailand was financing their current account deficit with capital inflows .When Thailand had current account deficits of about 9% of GDP it meant that capital was flowing into the country (imports are greater than exports). This capital inflow supported expenditures greater than current production. The reversal of the current account deficit is the result of the end of this inflow of capital. With foreigners unwilling to invest in Thailand the capital inflow stopped. But the accumulated debt must be serviced. So now Thailand must export capital; hence, the current account surplus. That is, Thailand must consume less than it produces so it can export capital to service its foreign debt. A sudden decrease in expenditure -- whether it be government spending, consumption, or investment -- of this magnitude - is rather severe indeed. Had the withdrawal been less sudden more gradual adjustment could have occurred. For example, if the capital inflow had been used for investment, and had this led to higher future income, it would have been possible to service the debt out of the increased income. Presumably, it was the fear that the inflow was not being used effectively that led to the reversal in the capital account balance. As an aside from the specifics of this question, we can note that it touches on an important classic controversy in international economics: the transfer problem. Thailand must effect a transfer to the rest of the world to repay its debt. To do so it must increase its current account balance. But to effect this transfer it may be necessary for the currency to depreciate in real terms. This increases the cost to Thailand of the transfer. Question 2 In order to answer to this question appropriately, it is necessary to divide in two periods ( short-term and long-term) the impact of a unexpected drop in a country’s saving rate on its domestic currency. Short-Term
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Thus , in short term , the interest rate would increase , and would create an inflow of money which is responsible of the appreciation of the currency.
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