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Chapter 15
International
Trade in
Goods and
Assets
Copyright © 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.
© 2014 Pearson Education, Inc.
1-2
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.
© 2014 Pearson Education, Inc.
1-3
Lifetime Budget Constraint
The representative consumer’s lifetime budget constraint:
C'
T'
C
T 
1 r
1 r
© 2014 Pearson Education, Inc.
1-4
Government
The government’s intertemporal budget constraint:
G
© 2014 Pearson Education, Inc.
G'
T'
T 
1 r
1 r
1-5
Figure 15.1
The Two-Period Small Open-Economy Model
© 2014 Pearson Education, Inc.
1-6
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.
© 2014 Pearson Education, Inc.
1-7
Figure 15.2
Deviations from Trend in the Current Account
Surplus and GDP
© 2014 Pearson Education, Inc.
1-8
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:
B'
C G Y 
B
1 r
• Future period budget constraint:
C ' G '  B ' Y '
© 2014 Pearson Education, Inc.
1-9
Constraints for the Nation
• National present-value budget constraint:
C ' G '
Y'
C G
Y B
1 r
1 r
• Limited commitment constraint:
• Or:
B '  v
v
C G Y  B
1 r
© 2014 Pearson Education, Inc.
1-10
Figure 15.3
Default is Chosen in the Current Period
© 2014 Pearson Education, Inc.
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Figure 15.4
Default is not Chosen
© 2014 Pearson Education, Inc.
1-12
Default
• When does a nation default on its debts?
v
B
1 r
• Default occurs when national debt is large, when the
perceived future penalties from defaulting are small,
and when the real interest rate is high.
© 2014 Pearson Education, Inc.
1-13
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.
© 2014 Pearson Education, Inc.
1-14
Figure 15.5
A Small Open-Economy Model with Production
and Investment
© 2014 Pearson Education, Inc.
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Figure 15.6
An Increase in the World Real Interest Rate
© 2014 Pearson Education, Inc.
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Figure 15.7
A Temporary Increase in Government Spending
© 2014 Pearson Education, Inc.
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Figure 15.8
An Increase in Current Total Factor Productivity
© 2014 Pearson Education, Inc.
1-18
Figure 15.9
An Increase in Future Total Factor Productivity
© 2014 Pearson Education, Inc.
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Figure 15.10
Investment as a Percentage of GDP
© 2014 Pearson Education, Inc.
1-20
Figure 15.11
Current Account Surplus as a Percentage of GDP
© 2014 Pearson Education, Inc.
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