CH 16 : Policies on Open Economy

Question 1

Effect of Govt Deficits?

Answer 1

• Reduce national saving and hence the supply of loanable funds.
• Drive up interest rate.
• Crowds out domestic investment.
• Cause net capital outflow to fall (NZ Investment abroad falls and foreign investment in NZ increases).

NZD more appealing as high interest rate, NZ investors cut back on foreign investment. Appreciation of NZD.

Question 2

Trade Policies?

Answer 2

• Does not change national saving or domestic investment.
• No change in interest rate as nothing happens in the loanable funds market.
• No change in net exports and the CAB.

Question 3

Political Instability?

Answer 3

Capital Flight: Country going down. Investors concerned about safety of investment, so demand for assets falls.
- Interest rates decrease, domestic currency depreciates.