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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 balanced trade, illustrate graphically and explain verbally how the following (ceteris paribus) events affect saving, investment, and the trade balance in this economy.

1. Foreign governments decide to raise their taxes, causing a change in the world real interest rate

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b) Now the taxes are increased across the globe so that world interest rate decreases. This suggests that the interest rate on domestic investment falls too. This implies that domestic investment increases. This shifts the Net capital outflow (S – I) curve to the left. Real exchange rate appreciates thus decreasing Net exports (NX). Hence, trade deficit occurs

Rahul Sunny answered 2 years ago
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