Explain why government budget deficits crowd out private investment spending in a closed economy, but crowd out net exports in a small open economy.

Explain why government budget deficits crowd out private investment spending in a closed economy, but crowd out net exports in a small open economy. Assume prices are flexible and that factors of production are fully employed in both economies. Assume there is perfect capital mobility for the small open economy

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Expert Solution

In the closed economy, the increase in the budget deficit reduces national saving and increases the interestrate, which crowds out (decreases) private investment spending. In the small open economy, the budgetdeficit reduces national saving, which increases the real exchange rate. The increase in the real exchangerate crowds out (decreases) net exports.

Rahul Sunny answered 1 year ago

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