Open-Economy Macroeconomics

Practical Class 3
Saving and Investment

1) Saving and Investment in Japan (5 minutes)

Suppose Japan has a GDP of $5000 billion, and that its national saving rate is 25%. Assuming
Japan is an open economy,
a) calculate Japan’s investment if net exports are 1% of GDP.
b) calculate Japan’s exports if imports are valued at $650 billion.

2) Saving and Investment in a small open economy (5 minutes)

Consider the following diagram of a small open economy:

a) Calculate net exports and capital outflow when the world real interest rate is 7%.
b) Calculate net exports and capital outflow when the world real interest rate is 5%.

3) Closed vs. small open economy (35 minutes)

Consider an economy described as follows. We know furthermore that the government budget is
balanced.

𝑌 = 1000
𝐶 = 100 + 0,8 ∙ (𝑌 − 𝑇) − 100 ∙ 𝑟
I = 1000 − 150 ∙ r
𝐺 = 200
a) Derive the private saving and the government saving function.
b) Derive the social saving function.
c) Find the equilibrium real interest rate in a closed economy.
d) Suppose that G is decreased by 100. Compute again the private saving, government saving,
national saving and investment. Explain what happens!
e) After the market opening to the world, the actors of the small economy find that the world real
interest rate is 3% (𝑟 = 3). What will be the balance of the NX?
f) Suppose that G is decreased by 100. Compute again the private saving, government saving,
national saving and investment. Explain what happens!

4) The effects of an expansive fiscal policy (30 minutes)

Show graphically the effect of an increase in government purchases on the real interest rate,
saving and net export…
 a) in a closed economy! What will happen? How do we call this phenomenon?
b) in a small open economy, assuming that the world real interest rate is above the closed
economy’s equilibrium real interest rate! What will happen? How do we call this phenomenon?
c) in a large economy assuming that the world real interest rate is above the closed economy’s
equilibrium real interest rate! What will happen?

5) Discussion topics: What is crowding out? (20 minutes)

Video about the crowding out effect
Questions:
a) What is the crowding out effect?
b) How does the size of social saving change with the increase in government spending?
c) Why is crowding out effect less of a problem during a recession?
d) Give an example of when the government made investments during economic downturns.