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Enron Mail |
Here are some recent questions I've gotten from your classmates and my
answers to them. < Thanks for the interesting articles. Could you < explain the following < statements from the Argentina article? Specifically < what is this < financing gap referred to below? How does it relate to < the fiscal deficit? < < Two basic scenarios have emerged. The more cautious is < that Argentina, held back by its strong currency and < lack of competitiveness in the region, will at best < see anaemic growth next year. That would be unlikely < to raise much enthusiasm among foreign investors, and < could complicate Argentina's task in raising the < Dollars 17bn or more it needs from the capital < markets to cover next year's financing gap. Basically, this is what the country needs to come up with to balance its Current account deficit. Suppose everything is in balance but then a foreign exporter like Boeing sells a plane to Argentina but decides not to keep its pesos in Argentina in a bank account or by reinvesting it in the economy but instead to convert its proceeds into dollars. Now unless an equivalent amount of pesos is invested by some other foreigners in Argentina (converting their dollars into Pesos), the currency board will have to sell dollars to Boeing in exchange for pesos and decrease the supply of pesos in the economy and reduce its foreign reserves. Now think of millions of transactions going on. If on balance, argentina has to use its foreign reserves to balance its current account it will start to deplete them. At some point it would either have to devalue (to make it more expensive for Boeing to sell pesos for dollars) or effectively raise interest rates to very high levels in order to attract investment. Now, with a fixed exchange rate Argentina cannot devalue. so it must raise interest rates which would further weaken the economy. One solution is to lower its budget deficit. This decreases the country's total borrowing needs and implies that interest rates will decline helping spur domestic investment. This also helps to restore foreign investors' confidence. This should lower the risk premium and bring down interest rates more. <In terms of what shifts the IS-LM curve, are these things such as: < a. China's potential entry into WTO which would open up the market to increased < foreign investment thus, increasing competition which would result in increased < consumption (lower prices) and unltimately a shifting of the IS curve because < there would be a greater demand for goods and services This is really too indirect and long-term, you really want something that directly changes government spending or some sudden decision to change consumption or investment behavior in order to shift the IS curve. It would be more like Japan's decision to stimulate the economy through more government spending. Or say Brazil lowering pension payments thereby shifting the IS to the left. Or how countries are suddenly forced to invest to counter Y2K < In the book on p. 193, it says "expansionary fiscal policy abroad reduces investment." < Not clear here. This assumes that the foreign countries have a big effect on world savings (if not there is no effect). In this case if they spend more they essentially reduce the amount of funds available to everyone else to borrow. This drives up the world interest rate which lowers investment since the costs of investment is now higher (I is a function of r) < P.194 on chart: why doesn't r* go up? This is because in a small open economy, the interest rate is equal to the world interest rate which is fixed. The country is too small to affect r. The idea is exactly the same as in micro when we say that firms are price takers. here the price is r. < In Japan, how does 0% r get rid of deflation? Think of it simply as increasing the money supply. In the classical model (see p154-158). A higher M results in higher prices. This is the opposite of deflation where prices fall.
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