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3. Effects of a government budget deficit Consider a hypothetical open economy. The following table presents data on the relationship between various real interest rates and national saving, domestic investment, and net capital outflow in this economy, where the currency is the US dollar. Assume that the economy is currently experiencing a balanced government budget. Real Interest Rate (Percent) 7 National Saving (Billions of dollars) 50 Domestic Investment (Billions of dollars) 20 Net Capital Outflow (Billions of dollars) -10 6 45 30 -5 5 40 40 0 4 35 50 S 3 30 60 10 2 25 70 15 Gven the information in the preceding table, use the blue points (orde 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. Market for Loanable Funds 9 Demand Supply REAL INTEREST RATE + Equilibrium 100 20 40 30 QUANTITY OF LOANABLE FUNDS 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 vou derived in the previous graph Net Capital Outflow X 10 NCO Em NCO REAL INTEREST RATE 15 NET CAPITAL OUTFLOW (lions of dollars Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest ratemples that the economy is experiencing Now, suppose the government is experiencing a budget deficit. This means that loanable funds. which leads to After the budget deficit occurs, suppose the new equilibrium real interest rate is 7%. The following graph shows the demand curve in the foreign currency exchange market. Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate imples that the economy is experiencing Now, suppose the government is a trade surplus get deficit. This means that which leads to a trade deficit ds. After the budget deficit occurs, su balanced trade Juilibrium real interest rate is 7%. 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. Because of the relationship between net capital outflow and net experts, 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 loanable funds. which leads to national saving will increase After the budget deficit occurs, suppose the new equilibrium real interest rate is currency exchange market. national saving will decrease jemand curve in the foreign domestic investment will increase domestic investment will decrease Use the green line (triangle symbol) to show the supply curve in this market ber urple line (diamond symbol) to show the supply curve after the budget delict. Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the e that the economy is experiencing Now, suppose the government is experiencing a budget deficit. This means that loanable funds. an increase in the supply of oppose the new equilibrium real interest rate is 7%. The following graph shows a decrease in the supply of an increase in the demand for ol) to show the supply curve in this market before the budget deficit. Then us a decrease in the demand for Judget deficit. Use the green line (triangle symbol) to show the supply curve in this market before the budget defiot. Then use the purple Aine (diamond symbol) to show the supply curve after the budget deficit. Market for Foreign-Currency Exchange 10 A inical Supply Supply with Delt REAL EXCHANGE RATE Demand -20 -15 15 20 - 10 0 5 10 QUANTITY OF DOLLARS (Billions) 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
