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# 0% Loanable Funds Model Closed economy: domestic savings = domestic investment 6.0% = 5.0% (in percent = 4.0% if 3.0% base Real interest rate (I @...

Consider an exogenous reduction of public saving of 1 percent and investigate how this change affects the macroeconomic equilibrium in the case in which the saving function is sensitive to changes in the interest rate.

Questions:

·       Why could the saving function be sensitive to interest rate changes? Listing at least one reason why this might be the case.

·       Compare the outcomes in the two cases for private saving, the government budget, national saving, investment, and the equilibrium interest rate.

7.0%
Loanable Funds Model
Closed economy: domestic savings = domestic investment
6.0%
= 5.0%
(in percent
= 4.0%
if 3.0%
base
Real interest rate (I
@ 2.0%
1.0%
alt(i)
0.0%
14.0%
15.0%
16.0%
17.0%
18.0%
19.0%
20.0%
Savings and Investment (in percent of output)
Autonomous shifts to savings and investment
Investment
aut
0.0%
0.0%
Private Savings
auts
0.0%
0.0%
NOTE: Keep the numbers &quot;small&quot; -
absolute values should be 1% or less.
Public Savings
autPUB
0.0%
1.0%
Be sure to add a percent &quot;%&quot; sign!
Qualitative description of autonomous shifts
Investment
aut
Private Savings
auts
What is the story? Why did shift(s) occur?
Public Savings
Outward shift of public savings
-
autPUB
Results of Model
baseline
alt(i)
Total (Domestic) saving
S(private)+S(public)
17.3%
18.3%
Private Saving
S(priva
17.3%
17.30%
Public Saving
S(Public)
0.0%
1.0%
Numerical results from a loanable funds model
Investment
17.30%
18.3%
-- SOLUTIONS
Real interest rate
3.0%
1.3%
Qualitative description of model results (relative to baseline)
Total (Domestic) saving
S(private)+S(public)
Increase in total saving
Private Saving
S(private)
...
Public Saving
S(Public)
Increase in public saving
Be prepared to discuss -- why did you get these
Increase in investment
results?
Investment
Real interest rate
req
Decrease in real interest rate

Key assumptions of model:
Interest Rate Semi-Elasticities -- percent change of output in response to a 1% change in interest rate.
Investment Expenditures
-0.6
These are the model's main parameters --
Domestic Saving (private only)
Ds,
sensitivities of investment and savings to
0
output.
Structural Components (percent of output)
Investment
17.3%
These are baseline ratios of saving and
sh
Private Savings
*(1-7)
17.3%
investment to output -- during &quot;normal times&quot;
Public Savings
O PUB *T
0.0%
(no shifts)
Natural rate of interest
NAT
3.0%
The natural rate of interest is that interest
We solve for the interest
Where did we get those
rate observed during &quot;normal&quot; times.
rate using this equation.
reg = rNAT 4 (aut, + autpuB -aut,)
Output
Inflation
numbers?
2.4
2.9
Interest RONLINE FEATURE
4.6
I=Y*{ y +
Pur (r - rNAT)
+
aut,
Structural
Autonomous
component
Response of investment
component
to interest rate
Equations for investment and
saving.
S(private) = Y* {o*(1- t)+ (s,, (r - rNAT )
+
aut,}
Structural
component
Response of consumption
Autonomous
to interest rate
component
Sum to obtain
S(public) = YP * (0pug #T)+ autpug = GBS
total savings.
Structural
Autonomous
component
component

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