Chapter 14

Question 1

Assumptions Open Economy Model

Answer 1

r* = real interest rate of the entire world
r = real interest rate of a small open economy

1. Domestic and foreign financial assets are perfect substitutes - same maturity, same risk etc.
2. Perfect capital mobility - no restrictions on international trade in assets.
3. Economy is small - cannot affect the world interest rate r*
4. • 2. -> r=r*
5. -> r* is exogenous

Question 2

Small Open Economy

Answer 2

The exogenous world interest rate determines investment and the difference between saving and investment determines net capital outflows and net exports.

Question 3

Expansionary Fiscal Policy

Answer 3

Increase in G

Decrease in T

Question 4

Contractionary Fiscal Policy

Answer 4

Decrease in G

Increase in T

Question 5

Expansionary Fiscal Policy at Home

Answer 5

An increase in G or decrease in T reduces saving.

No change in I
NX and savings both falll.