[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Review and Practice
SUMMARY
1. In an open economy, investment can be financed from
domestic national saving or borrowing from abroad.
2. In a small open economy, changes in national saving will
not affect the international real interest rate or the level
of domestic investment. Changes in national saving will
affect the level of net capital inflows.
3. In a large open economy such as the United States’, a fall
in national saving will raise the real interest rate. This
rise attracts net capital inflows and moderates the
decline in domestic investment.
4. The basic trade identity states that net exports plus net
capital inflows equal zero. A trade deficit must equal net
capital inflows; a trade surplus must equal capital outflows.
5. Changes in the exchange rate ensure that net exports
move in tandem with net capital flows.
KEY TERMS
open economy
capital inflows
capital outflows
net capital inflows
small open economy
large open economy
trade deficit
trade surplus
basic trade identity
exchange rate
depreciation
appreciation
REVIEW QUESTIONS
1. What are the consequences of an increased government
deficit for private investment in an open economy and in
a closed economy?
2. What is the relationship between the trade deficit and
an inflow of foreign capital?
3. What is the relationship between the trade deficit and
the fiscal deficit?
4. What is the saving-investment identity for an open
economy?
5. What is the exchange rate? How is it determined?
What role do adjustments in the exchange rate play in
ensuring that capital inflows equal the trade deficit?
PROBLEMS
1. Suppose a certain country has private saving of 6 percent
of GDP, capital inflow of 1 percent of GDP, and a
balanced budget. What is its level of investment? If the
budget deficit is 1.5 percent of GDP, how does your
answer change?
2. Why does it make a difference if a country borrows
abroad to finance the expansion of its railroads or to
finance increased Social Security benefits for the elderly?
3. U.S. foreign indebtedness is greater than that of Mexico,
Brazil, and Argentina combined. Does this necessarily
mean that the United States has a larger debt problem
than those countries? Why or why not? Can you think of
a situation in which an individual with debts of larger
value may actually have less of a debt problem than
someone with less debt?
4. If Congress were to pass a law prohibiting foreign
investors from buying U.S. Treasury bills, would this
prevent government borrowing from leading to capital
inflows? Discuss.
5. Japan had large trade surpluses during the 1980s.
Would this cause Japan to be a borrower or to be a
lender in international capital markets?
6. If a nation borrowed $50 billion from abroad one year
and its imports were worth $800 billion, what would be
the value of its exports? How does the answer change
if, instead of borrowing, the nation lent $100 billion
abroad?
7. If U.S. investments increase and world interest rates
rise, what is the effect on private investment in other
countries? What is the effect on U.S. national saving?
REVIEW AND PRACTICE ∂ 583