Problem Set 6 Key

# S interest rates and output in a normal situation in

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Unformatted text preview: es. From the point of view of the US: a. What would happen to financial flows in the balance of payments accounts? This is a shock to Net Capital Outflows CF(r). For a given level of the domestic interest rate, investors will choose to purchase more US securities. That is, CF will decrease. b. Assume that this means that CF goes down in the IS\$ MP\$ model. This would shift the CF part of the IS\$ curve to the left. Show this in the IS\$ MP\$ diagram. The IS\$ curve is given by: IS\$ = C + I(r) + G + CF(r). Here only CF(r) is changing, and we assume that because of fear the shift is parallel. (That is, scared investors are dumping a fixed amount into the US, regardless of the domestic interest rate.) For each of the following, explain your answer in words and using the IS\$ MP\$ diagram. c. What would be the impact of the flight to safety on U.S. interest rates and output in a “normal” situation? In a normal situation, the increase in capital inflows will decrease net capital outflows (CF), which means...
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