Question

what happens to saving (consumption), investment, interest rate, and current account in response to "good news" (anticipated increase in A2) in a production economy?

Answer 1

Ans.- A large and persistent external deficits often lead to calls for policy measures such as dilateral trade negotiations, tariffis, and import quotas, directed at restoring balance between exports and imports. However, current account deffects ultimately raflact a disparty between savings and investment; fundamental national income accountig identities ensure that the current account is equal not only to the defference between exports and imports, broadly defined, but also to the defference between savings and investment (krugman 1991).

Therfore, the issu of how current account balance is achieved in practice can be viewed in terms of whether it is savings or investment that adjusts to an external imbalance.

To the extent that a country that borrows from abroad does not default on its devbt obligations, high current account defects must eventually we followed by higher netional savings or lower investmant. In a series of influeneial articles, feldstien,( 1992 ) arued that while, in the short run, inflows of foreign capital can offset the difference between national investment and national savings, in the long run, the revalancing of the current account accurs mainly trough changes in investment. This is becouse a country's saving rate is, in the long run, predetprmined by household's attipuves toward savings and borrowing, by the fiscal incentives for private savings, and by the public attitude toward budget deffics. As such, a cpuntry's savings rate ultimately constrains the rate of investment; low lebels of national savings lead, in the lng run, to low lebelss of  investment, with potentially importance implications for a country's future standard of living. Felgstein's preferred policy conclusion is that govenment measures aimed at raising a country's savings rate will generate an almost one- for-one increase in its long- run investment rate.

While the ebility of government to termanently raise a country's savings rate remais highly controversial, it is still the case that solvency emplies that permanent changes in savings or investment must lead to changes in the other variable of approximately the same ammount.