Part 1 Flashcards
Temporary Negative Output Shock
Reduction in Savings or borrowing against future income levels. Smooth consumption over time = Country runs a larger trade deficit, and CA deteriorates.
Temporary Positive Output Shock
Hh save part of the increase in income for future consumption. TB and CA improves
Economies will tend to finance temporary shocks by
borrowing or lending on international capital markets
(large movements in the C.A.)
Economies will tend to finance permanent shocks by
varying consumption in both periods up or down
(C.A. largely unchanged)
Anticipated Income output Shock
causes an expansion in consumption and a deterioration of TB and CA.
HH feels richer, and wants to consume more in both periods, but Q1 is unchanged. Increase in C causes the TB to deteriorate
Increase in the world interest rate
Income effect: Makes debtors poorer and creditors richer.
Substitution effect: Makes savings more attractive because the rate of return on foreign assets is higher. /Substitute present for future consumption/
If income and substitute effect have opposing effects on savings
The substitution effect dominates the income effect
Substitution effect
An increase in R* makes consumption in P1 decline, with improvement in the T.B and C.A.
Income Effect
Increase in R*, decrease in C in P1 if the country is a debtor, increase in C in P1 if the country is a creditor
Wealth Effect
If I am a debtor: I will opt for tomorrow’s consumption rather than future consumption. Tomorrow, we must pay less interest payments
Two regions U.S. and RoW an increase in the interest rates
Induces U.S. HH to increase savings in P1 and U.S. firms to cut investment in the same period.
C.A. of the U.S. improves as the interest rate increases
A temporary output increase in a large country
depresses the world interest rate
An expected future increase in output in a large economy
drives the world interest rate up
