Saving and Investment on the Global Two-Country Model, Essay Example

Y = AF(K) and Y* =A*F(K*), in this equations Y represent the real income, A represents positive  accounting variables in the state which include technology, effect of economic trend on level of productivity,  and K represents stock of the physical capital. If there is increase in technology country’s output will increase.  Consumption smoothening household will prefer to save some of the increased output in the period. This will increase marginal propensity to save and reduces marginal propensity to consume. Increased saving will increase the stock of the physical output. Home interest rates will reduce, as there is reduced expenditure, fiscal policy reduces government spending increasing investments. Balance of trade is in equilibrium and public debts is reduced the government is operating within its means and enjoying a period of financial stability. There is no variability in home interest rate to world interest rates. Foreign investors are attracted to invest in the country this will increase output in the short run and long run; this makes the home nation have perfect capital mobility. Saving and investment ratio determines the interest rates in the home economy.

Anticipated global liquidity expansion in home country will spark development before a financial crisis. If the home country has good regulatory environment tight fiscal and monetary policy the economy will be well transformed with a global boom. Real income will increase but home country will have to strain its resources given a equal positive factors of economy are equal both domestically and globally. Home country with high level of financial openness with developed financial intermediation will have high investment rates. A global boom will imply that country’s savings is reduced and all the funds channeled to investments. This creates surge capital current accounts inflows. Firms in the home country will choose increase to investment at any level of interest rate. Global boom can increase the prices of imports in the home country give a world interest rate. This will lead to imbalance of payments, current account deficits leading to increased interest rate in the home economy. Investments and saving will reduce in the short run. Consumption smoothening household will prefer to consume more; this will reduce the endowments from period 1 to period 2.

Rise in home productivity is attributed to increased investments and reduced consumption in the economy. There will be increased cash flow in the home country; tight regulation on fiscal and monetary policy will keep interest rates (rclo) in check. The home country will diversify its investments to reduce the risk in the end. There will be increased imports; this is attributed to positive increase in factors of production. When the global interest rates are higher than in the home economy, there will be increased   monetary value this leads to current account surplus. If the global interest rates are lower in the home economy, this implies that there is an account deficit. Fiscal policy will dictate amount of savings, increase government spending will reduce the saving, and this will spark a public debt with the home economy resorting to external borrowing to finance the budget deficits. Increased productivity increase the endowment, consumption smoothening will prefer to save much and reduce the expenditure.

Expansive fiscal policy will increase government spending as the government increases the development; this will lead to current account deficit (NX). This will leads to domestic borrowing or external borrowing in order for the country to finance viable development in the country. Domestic borrowing will increase the interest rates making the cost of living high. This will lead to high domestic interest rates compared global economy. The home country will spend more on imports compared to exports revenue; this will lead to imbalance of payment, raising the public debt. High interest rates reduces investments, marginal propensity to save will reduce marginal propensity to consume will increase. High interest rates will lead to high cost production this bring about cost and demand pull inflation in the economy. The home country faces a financial crisis; its currency devalues in the global market. The budget deficit will be promptly accompanied by current account deficits.

An impatient developing economy with a higher rate of preference, will strain it resources in order to achieve its target and goals (Q2) . Small percentage of the real income is set aside for recurrent  expenditure (Y1) and more to development activities (Y2). This increase the national investment demand, this would lead to current account deficits. This economy can be characterized by high taxation as the government target a lot of revenue in a short period to finance its projects. Investments will be financed by grants and foreign capital accounts. Increased country’s demand will increase its public debt, and increased balance of payments. The country will resort to foreign direct investment to finance its projects; this will increase foreign direct investment. External and domestic borrowing will increase the interest rate; this will scare away investors reducing the GDP. GDP will decline has the government increases its spending. Decline in GDP will sparks a lot of financial strains in the economy as the government finances it project, since for a short period the country need to realize a growth. Resources in the economy will not be fully utilized to achieve desired level of satisfaction. Inter-temporal budget constraint will reduce, discounted value of consumption will not be equal to initial stock of wealth in addition to present discounted endowment stream. The economy will not be able to finance its all expenditures at a go given a rapid expansion this will lead to financial instability in the economy.

An outward shift a country saves more at any given interest rate. This increases the current account the current account. Reduced government expenditure increases the gross domestic product; this reduces public debts, as the government is able to finance it budget. Increased saving reduces interest rates and stabilizes the exchange rates of the domestic currency; this triggers investment in the economy. Increased investments increase the cash flow in the economy in the end leading to surplus in the current accounts. Consumer smoothening will prefer to save some more also from the endowments this improves the cost of living and the living standards in the economy. The economy will grow at a faster rate, continued growth of the economy would lead to anticipated boom. The economy increased relation with external creditors to finance the ambitious.  The economy adopts fiscal and monetary policies that tighten liquidity, keeping interest rates and inflation in check in order to achieve set objectives.

Inward shift in a country consumes more that it saves. There is increased government expenditure, and consumer smoothening prefers to consume more from its endowments. Increased government spending will lead to current account deficits. The country will borrow domestically or externally to finance its budget.  It raises the public debt, which leads to high-interest rates. Increased government expenditure, would make the government borrow to finance its recurrent expenditure a state of financial instability. Home interest rates will be higher compared to global interest rates this would lead to an imbalance of payments and devaluation of the local currency High-interest rates will spur up inflation increasing the cost of living. Increased spending reduces investment and discourages potential investors in the home country this reduces the cash flow reducing the GDP. Reduced GDP would lead to reduced income per capita, a state of whereby a nation will not sustain its population this will lead to a slump in the economy.

Asian economy in 1990 is best characterized by the resurgence. The economy was in recession. Cash flows flowed continuously for five years because of outward shift increased investment in the economy that generated many cash flows in the economy. Rapid growth in the economy was due to international diversification of investment. First interest rest in Asian economy was relatively low lure investors from foreign countries to invest in the Asian economy.