Reference no: EM131483540

Classical small open economy model: Suppose for the sake of this problem that the U.S. can be modeled as a small open economy. (This is not exactly true, but for many questions it may still give us good insights.) Remember that the U.S. is a country that typically runs a large current account deficit and a large capital account surplus.

a) Draw a loanable fund market diagram that roughly corresponds to the U.S. economy. Be sure to locate the world real interest rate r* so that your diagram shows a capital account surplus (I > S).

b) Draw a net exports diagram that roughly corresponds to the U.S. economy. Be sure that your diagram shows a current account deficit.

c) In the early 2000s, then-Chairman of the Federal Reserve Ben Bernanke said that there was a "global savings glut"-an exogenous increase in the supply of world savings. What is the effect of a global savings glut on the world real interest rate? (Remember that the world is a closed economy.) Use a loanable funds diagram to help illustrate your answer.

d) In response to the global savings glut, what happens to U.S. national savings, investment, and the capital account balance? (Assume that there is no increase in the U.S. savings rate, which was the case at the time, but remember that there is an effect on the world real interest rate, from part c.) Use a loanable funds diagram (for the U.S.) to help illustrate your answer. e) Continuing part d), what happens to the U.S. trade balance and real exchange rate? Use a net exports diagram to help illustrate your answer.