Question

B. Moldavia, an open economy initially in LR equilibrium, experiences the
following two macroeconomic events:
1. The Moldavian government cuts government spending and thereby
reduces its budget deficit.
2. International financial markets begin to diversify their portfolios
away from Moldavian assets.

As a result of these two events, real interest rates in Moldavia do NOT change.
Using a three-panel open economy set of diagrams, show the effects of these
changes on the LR equilibrium levels of national savings, domestic investment,
and net exports in Moldavia (be sure your graphs reflect the effects on real
interest rates as well). Explain your results. Is the change in net exports driven
more by changes in S or more by changes in I in Moldavia? Why?

i. The decline in the budget deficit ______ public savings in Moldavia at each level
of the real interest rate, shifting the S curve for loanable funds _____.
a. Increases ; out and to the right
b. Increases ; back and to the left
c. Decreases ; out and to the right
d. Decreases ; back and to the left

ii. International rebalancing of portfolios away from Moldavian assets means that
foreigners’ purchases of Moldavian assets will ______, thus _____ NCO in
Moldavia.
a. Rise ; increasing
b. Rise ; decreasing
c. Fall ; increasing
d. Fall ; decreasing

iii. Given (as stated above) that these two events do not change the equilibrium real
interest rate in Moldavia, equilibrium investment _______ , and the equilibrium
level of NCO ________.
a. Rises ; rises
b. Falls ; rises
c. Does not change ; rises
d. Does not change ; falls

iv. These two events combine to _______ the equilibrium level of the real exchange
rate in Moldavia, __________ the relative price of Moldavian goods and services
relative to foreign goods and services, and _________ the equilibrium level of net
exports in Moldavia.
a. Raise ; increase ; lower
b. Raise ; decrease ; raise
c. Reduce ; increase ; lower
d. Reduce ; decrease ; raise

v. This change in NX is entirely driven by the change in ______ because _____ .
a. National savings ; investment decreases.
b. National savings ; investment does not change.
c. Investment ; national savings decreases.
d. Investment ; national savings does not change.

Answer 1

1. i. The decline in the budget deficit ____INCREASES__ public savings in Moldavia at each level
of the real interest rate, shifting the S curve for loanable funds __OUT AND TO THE RIGHT___. As the budget deficit decreases, the Government starts to save more than before. Hence, public savings increase and supply of loans shifts outwards.

2. International rebalancing of portfolios away from Moldavian assets means that
foreigners’ purchases of Moldavian assets will ___FALL___, thus __INCREASING___ NCO in
Moldavia. As foreigners diversify away from Moldovian assets, thus Net Capital outflow will increase. When we attract foreign investment, we reduce net capital outflow (since more capital is entering the economy).

3. Given (as stated above) that these two events do not change the equilibrium real
interest rate in Moldavia, equilibrium investment _DOES NOT CHANGE______ , and the equilibrium
level of NCO _______FALLS_.

4. These two events combine to __RAISE_____ the equilibrium level of the real exchange
rate in Moldavia, ______DECREASE____ the relative price of Moldavian goods and services
relative to foreign goods and services, and _____RAISE____ the equilibrium level of net
exports in Moldavia.

5. This change in NX is entirely driven by the change in ___NATIONAL SAVINGS___ because ___INVESTMENT DOES NOT CHANGE__ .