Devise a simple supply-demand picture of equilibrium

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Reference no: EM131167747

The fifth Case Study discussed the big global imbalances of the 2000s and suggested that one can analyze factors determining world real interest rates in terms of the balance between the world demand for savings (in order to finance investment) and the world supply of savings (just as in a closed economy-which the world is).

As a first step in formalizing such an analysis, assume there are no international differences in real interest rates due to expected real exchange rate changes. (For example, you might suppose that yours is a long-run analysis in which real exchange rates are expected to remain at their long-run levels.)

As a second step, assume that a higher real interest rate reduces desired investment and raises desired saving throughout the world.

Can you then devise a simple supply-demand picture of equilibrium in the world capital market in which quantities (saved or invested) are on the horizontal axis and the real interest rate is on the vertical axis?

In such a setting, how would an increase in world saving, defined in the usual way as an outward shift in the entire supply-of-savings schedule, affect equilibrium saving, investment, and the real interest rate?

Relate your discussion to the fifth Case Study in the chapter and to the paper by Ben S. Bernanke in Further Readings. [For a classic exposition of a similar model, see Lloyd A. Metzler, "The Process of International Adjustment under Conditions of Full Employment: A Keynesian View," in Richard E. Caves and Harry G. Johnson, eds., Readings in International Economics (Homewood, IL: Richard D. Irwin, Inc. for the American Economic Association, 1968), pp. 465-486.]

Reference no: EM131167747

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