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Chapter 15
International Trade in
Goods and Assets
Copyright © 2014 Pearson Education, Inc.
1-2© 2014 Pearson Education, Inc.
Chapter 15 Topics
• A two-period open economy model – the current account.
• Credit market imperfections and default.
• Production, investment, and the current account.
• Effects of changes in the world real interest rate, government spending, and productivity.
1-3© 2014 Pearson Education, Inc.
A Two-Period Small Open Economy Model
• Two periods – current period and future period.
• Representative consumer with exogenous current-period and future-period incomes.
• The SOE is a price-taker on world credit markets – the real interest rate is exogenous.
• The current account surplus here is equal to savings in the SOE, as there is no investment.
1-4© 2014 Pearson Education, Inc.
Lifetime Budget Constraint
The representative consumer’s lifetime budget constraint:
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r
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1
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Government
The government’s intertemporal budget constraint:
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Figure 15.1The Two-Period Small Open-Economy Model
1-7© 2014 Pearson Education, Inc.
Credit Market Imperfections and Default
• Problems with national indebtedness were important during the financial crisis and after, particularly in southern Europe.
• Use ideas on credit market frictions from Chapter 10 to address sovereign debt issues – model of limited commitment.
Figure 15.2Deviations from Trend in the Current Account Surplus and GDP
1-8© 2014 Pearson Education, Inc.
1-9© 2014 Pearson Education, Inc.
Budget Constraints for the Nation
• B = nation’s (private sector + government) debt to the world at beginning of current period.
• B’ = nation’s debt at beginning of future period• Current period budget constraint:
• Future period budget constraint:
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1-10© 2014 Pearson Education, Inc.
Constraints for the Nation
• National present-value budget constraint:
• Limited commitment constraint:
• Or:
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1-11© 2014 Pearson Education, Inc.
Figure 15.3Default is Chosen in the Current Period
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Figure 15.4Default is not Chosen
1-13© 2014 Pearson Education, Inc.
Default
• When does a nation default on its debts?
• Default occurs when national debt is large, when the perceived future penalties from defaulting are small, and when the real interest rate is high.
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1-14© 2014 Pearson Education, Inc.
A Small Open Economy with Production and Investment
• Works the same as the real intertemporal model, except the real interest rate is determined on world credit markets, and given to the SOE.
• Current account surplus always adjusts so that the aggregate supply and aggregate demand curves intersect at the world real interest rate.
1-15© 2014 Pearson Education, Inc.
Figure 15.5A Small Open-Economy Model with Production and Investment
1-16© 2014 Pearson Education, Inc.
Figure 15.6An Increase in the World Real Interest Rate
1-17© 2014 Pearson Education, Inc.
Figure 15.7A Temporary Increase in Government Spending
1-18© 2014 Pearson Education, Inc.
Figure 15.8An Increase in Current Total Factor Productivity
1-19© 2014 Pearson Education, Inc.
Figure 15.9An Increase in Future Total Factor Productivity
Figure 15.10Investment as a Percentage of GDP
1-20© 2014 Pearson Education, Inc.
Figure 15.11Current Account Surplus as a Percentage of GDP
1-21© 2014 Pearson Education, Inc.