1 3. Effects of a government budget deficit Suppose a hypothetical open economy uses the U.S....

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1 3. Effects of a government budget deficit Suppose a hypothetical open economy uses the U.S. dollar as currency. The table below presents data describing the relationship between different real interest rates and this economy's levels of national saving, domestic investment, and net capital outflow. Assume that the economy is currently operating under a balanced government budget. Real Interest Rate (Percent) National Saving (Billions of dollars) Domestic Investment Net Capital Outflow (Billions of dollars) 7 45 25 6 40 30 (Billions of dollars) -10 -5 5 35 35 D 4 30 40 5 3 25 45 10 2 20 50 15 Given the information in the table above, use the blue points (circle symbol) to plot the demand for loanable funds. Next, use the orange points (square symbol) to plot the supply of loanable funds. Finally, use the black point (cross symbol) to indicate the equilibrium in this market REAL INTEREST RATE 2 10 Market for Loanable Funds 20 40 QUANTITY OF LOANABLE FUNDS 80 100 Demand ---0- Supply +. Equilibrum 27 On the following graph, plot the relationship between the real interest rate and net capital outflow by using the green points (triangle symbol) to plot the points from the initial data table. Then use the black point (X symbol) to indicate the level of net capital outflow at the equilibrium real interest rate you derived in the previous graph REAL INTEREST RATE 20 15 -10 Net Capital Outflow 10 50 5 10 15 20 NET CAPITAL OUTFLOW (Billions of dollars) NCO + Eqm. NCO 13 Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate implies that the economy is experiencing Now, suppose the government is experiencing a budget deficit. This means that which leads to loanable funds. After the budget deficit occurs, suppose the new equilibrium real interest rate is 6%. The following graph shows the demand curve in the foreign- currency exchange market. Use the green line (triangle symbol) to show the supply curve in this market before the budget deficit. Then use the purple line (diamond symbol) to show the supply curve after the budget deficit REAL EXCHANGE RATE Market for Foreign Currency Exchange 10 20 15 10 0 Demand 6 10 15 20 QUANTITY OF DOLLARS (Billions). Initial Supply Supply with Defict 13 Summarize the effects of a budget deficit by filling in the following table. Real Interest Rate Real Exchange Rate Trade Balance Effects of a Budget Deficit 1 3. Effects of a government budget deficit Suppose a hypothetical open economy uses the U.S. dollar as currency. The table below presents data describing the relationship between different real interest rates and this economy's levels of national saving, domestic investment, and net capital outflow. Assume that the economy is currently operating under a balanced government budget. Real Interest Rate (Percent) National Saving (Billions of dollars) Domestic Investment Net Capital Outflow (Billions of dollars) 7 45 25 6 40 30 (Billions of dollars) -10 -5 5 35 35 D 4 30 40 5 3 25 45 10 2 20 50 15 Given the information in the table above, use the blue points (circle symbol) to plot the demand for loanable funds. Next, use the orange points (square symbol) to plot the supply of loanable funds. Finally, use the black point (cross symbol) to indicate the equilibrium in this market REAL INTEREST RATE 2 10 Market for Loanable Funds 20 40 QUANTITY OF LOANABLE FUNDS 80 100 Demand ---0- Supply +. Equilibrum 27 On the following graph, plot the relationship between the real interest rate and net capital outflow by using the green points (triangle symbol) to plot the points from the initial data table. Then use the black point (X symbol) to indicate the level of net capital outflow at the equilibrium real interest rate you derived in the previous graph REAL INTEREST RATE 20 15 -10 Net Capital Outflow 10 50 5 10 15 20 NET CAPITAL OUTFLOW (Billions of dollars) NCO + Eqm. NCO 13 Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate implies that the economy is experiencing Now, suppose the government is experiencing a budget deficit. This means that which leads to loanable funds. After the budget deficit occurs, suppose the new equilibrium real interest rate is 6%. The following graph shows the demand curve in the foreign- currency exchange market. Use the green line (triangle symbol) to show the supply curve in this market before the budget deficit. Then use the purple line (diamond symbol) to show the supply curve after the budget deficit REAL EXCHANGE RATE Market for Foreign Currency Exchange 10 20 15 10 0 Demand 6 10 15 20 QUANTITY OF DOLLARS (Billions). Initial Supply Supply with Defict 13 Summarize the effects of a budget deficit by filling in the following table. Real Interest Rate Real Exchange Rate Trade Balance Effects of a Budget Deficit