A country exhibits the paradoxical situation of having negative net investment income (NII) of -100 and a
Question:
A country exhibits the paradoxical situation of having negative net investment income (NII) of -100 and a positive net international investment position (NIIP) of 1000. Economists’ opinions about this are divided. Group A thinks that the explanation lies in the fact that, because of the bad reputation of the country in world financial markets, foreign investors charge a higher interest rate when they lend to this country, relative to the interest rate the country receives on its investments abroad. Group B believes that domestic investors inflate their gross international asset positions to look like big players in the world market.
1. Calculate the interest-rate premium that would explain the paradox under group A’s hypothesis, assuming that the interest rate on assets invested abroad is 5 percent and that the country’s gross international asset position is 4000.
2. Calculate the amount by which domestic investors inflate their gross foreign asset positions under group B’s hypothesis assuming that the interest rate on assets and liabilities is 5 percent.
