Question
In: Economics
Consider the long-run model of a small open economy with perfect capital mobility.
Consider the long-run model of a small open economy with perfect capital mobility. Starting from an initial equilibrium with balanced trade, illustrate graphically and explain verbally how the following (ceteris paribus) events affect saving, investment, and the trade balance in this economy.
a. The domestic government implements a reduction in government purchases.
Solutions
Expert Solution
a) A cut in the government spending suggests that public saving will increase and thus, with unchanged private savings, national savings will rise. As a result, the Net Capital Outflow curve (S – I) shifts to the right. This is a small open economy so it would not affect the world real interest rate. Hence, the level of investment remains unaffected. Savings now exceeds investment so currency is depreciated, real exchange rate is reduced and there is a positive net capital outflow or a trade surplus
Rahul Sunny answered 2 years agoRelated Solutions
Consider the long-run model of a small open economy with perfect capital mobility. Starting from an...
Consider the long-run model of a small open economy with perfect
capital mobility. Starting from an initial equilibrium with
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the trade balance in this economy.
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