In an open economy, there are three sources of funds to finance investment: private savings (S_p), government savings (the difference between government revenues and expenditures, S_g ), and foreign borrowing, B:

a. Suppose a certain country has private savings of 6 percent of GDP, foreign borrowing of 1 percent of GDP, and a balanced budget. What is its level of investment?
b. Suppose now that the government runs a deficit of 3 percent of GDP, and investment and private savings remain unchanged. What must happen to foreign borrowing?
c. Suppose now that the government runs a defi cit of 3 percent of GDP, and this increases the interest rate. If this, in turn, leads to increased private savings to 7 percent of GDP and reduced investment from 7 to 6 percent of GDP, what happens to foreign borrowing?

Transcribed Image Text:

I = S₂ + Sg + B. P