Answered: Effects of a government budget deficit…

Principles of Economics 2e

2nd Edition

ISBN:9781947172364

Author:Steven A. Greenlaw; David Shapiro

Publisher:Steven A. Greenlaw; David Shapiro

Chapter22: Inflation

Section: Chapter Questions

Problem 18RQ: What is deflation?

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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 U.S. dollar. Assume that the economy is currently experiencing a balanced government budget.

Real Interest Rate	National Saving	Domestic Investment	Net Capital Outflow
(Percent)	(Billions of dollars)	(Billions of dollars)	(Billions of dollars)
7	40	25	-15
6	35	30	-10
5	30	35	-5
4	25	40	0
3	20	45	5
2	15	50	10

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.

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 .(trade defict, trade surplus, balance trade)

Net Capital Outflow
10
NCO
Egm. NCO
5 10
NET CAPITAL OUTFLOW (Billions of dollars)
20
15
10 -5 0
15
20
|
REALINTEREST RATE

Definition Definition Difference in value of a country's net exports and net imports for goods and services in a given period. A positive balance of trade is called a surplus and coincides with more net cash inflows into a country; a negative balance of trade deficit is a deficit and results in net cash outflows. A balance of trade surplus or deficit doesn't necessarily indicate a positive or negative situation for a country.

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