Question

Consider a large open economy that has a zero-current account balance. What are the effects on the world real interest rate, national saving, investment, and the current account in equilibrium if:

(a) future income rises?

(b) business taxes decline? Explain using graphs.

(For full credit make sure you label the axes and the curves)

Answer 1

a)When income increases levels of consumption will increase given the marginal propensity to consume. Also marginal propensity to import the import will increases and the current account will worse. Income rises, then consumption increases and also savings will decrease and interest rates will increase, as a result investment will decline.

b) the IS curve will shift towards right and leads a rise in interest rates and income level/ the current account balance will decrease as imports increases. The savings and investment will fall as interest rate increases.