Midterm Topic 8 Flashcards
“poor economy” –> poverty trap
low TFP, low GDP, low level of capital, low capital returns, low investment.
In a closed economy=low domestic saving and low investment== low future capital stock== low future GDP. (rinse and repeat)
ways out of the poverty trap
- TFP improvements –structural reforms and expenditures (challenge: public budget constraints, hard to survive)
- Foreign aid. Transfers to finance TFP and K [challenge: political constraints]
- International Funds Market. Lending and borrowing, repaid over time with future income.
conditions for success out of the poverty trap borrowing funds
- capital accumulation and future income growth (not for consumption or unproductive spending. borrowed funds go to investment in private and public capital and government spending focuses on TFP improvements)
- low, stable interest rates–for low borrowing costs and predictability for debt service. if the r(w) > r* with low TFP, this creates low capital returns and low investment, leading to the continuation of growing inequality.
- Accountability and transparency–for usage of funds any repayments. If there’s a risk of defaults / inability to pay, lenders can change risk premium or refuse to lend
self-fulfilling prophecy
risk of default goes up, RP goes up, r’ goes up, I(t) goes down, Y(t+1) goes down, risk of default goes up
[growing liability, shrinking income]
To prevent the downward long-run trend (self-fulfilling prophecy), alternative policies include (4)
- Reduction in domestic absorption (austerity)
- Refinancing and borrowing / risk reduction from international organizations
- Debt relief–“haircut”
- Foreign aid / transfers
Austerity
reduction in absorption, lowering consumption adn government spending so that current account and savings increases. preferred by lender
question: how much does consumption and government spending have to decrease to reduce RP and stabilize investment?
political challenge: how do you balance the lowering of C and G to uncertain benefits of reducing the risk premium (convincing citizens to be okay with cuts)?
Refinancing and borrowing from international organizations
IMF uses deposits and ratings backed by members states to get access to cheaper funds and lend those at lower interest rates. TRANSFERS RISK TO IMF AND WB (and member states bear the risk). they can also demand political reforms as a way to mitigate risk
preferred by private lenders (private banks, etc) and can also be preferred by borrowers (depends on demands vs. interests).
debt relief
full or partial forgiveness of loans (goes back into economy for more growth).
Preferred by the borrower (foreign liabilities goes down)
A country’s current account balance depends on…
its own domestic saving and domestic investment but also on foreign saving and foreign investment.
successful borrowing means…
either capital accumulation or more productive economic activity in the future (i.e. TFP increasing due to government spending)
developing countries borrow…
under the expectation of future increases in income
hypotheses for US current account deficit in 2000s
H1. US Twin deficit (government deficit went up due to military conflicts in Afghanistan and Iran)
H2. Real estate market prices went up, excess optimism and increase in perceived wealth –> US saving curve decreases.
H3. Global saving gut. Increase in global saving lowered international real interest rates and encouraged US borrowing (discouraged US saving)
reasons for the global saving glut
- emerging economies increased foreign reserves
- increase in price of oil –> oil exporting countries had a positive productivity shock that led to an increase in saving and CA
- Developed countries with aging populations–> saving to anticipate that
- US assets became attractive (tech, real estate market)
- export-driven growth policies in some countries, like China
