macro chapter 4 summary
Wealth accumulation and capital mobility
1. In an open economy which allows free international mobility of capital, part of domestic investment
may be financed by capital imports from abroad, and part of domestic saving may be
invested in foreign assets. It is then necessary to distinguish between the domestic capital
stock {the stock of capital invested in the domestic economy) and national wealth {the total
stock of assets owned by domestic residents). A country's stock of net foreign assets is equal
to the difference between its national wealth and the domestic capital stock.
2. In parallel to the distinction between the domestic capital stock and national wealth, one must
distinguisr between gross domestic product {GDP) which is the total output produced by the
factors of production employed in the domestic economy, and national income which is the
total income earned by the factors of production owned by domestic residents. National
income is equal to GDP plus the return to the country's net foreign assets.
3. The growth rate of a country's capital stock is given by its rate of domestic investment,
whereas the growth rate of national wealth is determined by the national savings rate. In a
closed economy saving and investment are identical and therefore perfectly correlated. In the
open ecoromy capital mobility reduces the correlation between saving and investment. The
current account on the balance of payments represents the difference between national saving and national investment. As an accounting identity, the increase in a country's net
foreign assets is given by the balance on its current account.
4. International capital mobility may take the form of international portfolio investment, where
households or institutional investors (including banks) acquire foreign assets to diversify their
portfolios, or it may take the form of foreign direct investment where the investor acquires a
controlling ownership share of foreign business assets. In recent decades both forms of
international investment have grown much more rapidly than world output and world trade, as
many governments have liberalized capital flows, and as improvements in information and
communication technologies have reduced the barriers to foreign investment. The growing
mobility of cap tal has caused a fall in the correlation between national rates of saving and
investment. In the euro area this correlation is now close to zero.
5. Capital is said to be perfectly mobile when domestic and foreign assets are perfect substitutes
and investors can instantaneously and costlessly switch between the two asset types.
In a small open economy which cannot affect the world interest rate or any other foreign
macroeconomic variable, perfect capital mobility implies that the correlation between national
saving and national investment tends to zero.
6. In our Solow model of a small open economy with perfect capital mobility, the domestic
capital intensity adjusts instantaneously to its steady state level determined by the international
interest rate. By contrast, national wealth per capita evolves gradually over time, since
any increase in wealth generates an increase in capital income, thereby raising aggregate
saving which in turn generates another increase in wealth, and so on.
7. The process of wealth accumulation in the small open economy is dynamically stable if and
only if the (effective) labour force grows at a rate exceeding the product of the savings rate
and the international real interest rate. When the labour force is measured in technologyadjusted
efficiency units, this stability condition will be met for all realistic parameter values.
8. By allowing free international capital flows, a country will be able to increase its national
income whenever the domestic steady state real interest rate in the absence of capital mobility,
r;, deviates from the world real interest rate, r. If r; > r, which will typically be the case in
a country with a relatively low savings rate, capital mobility benefits the domestic economy by
enabling firms to borrow at a world interest rate below the (initial) marginal return to domestic
investment. If r: < r, which will tend to be the case in a country with a relatively high savings
rate, domestic wealth owners gain because capital mobility allows them to invest their savings
at a higher (initial) rate of return abroad than at home. If wealth is unevenly distributed, capital
mobility will affect the distribution of income and may in fact hurt some domestic agents even
though it raises aggregate income.
9. While capital mobility enables domestic agents to take advantage of rate-of-return differentials
between the domestic and the foreign economy, it also makes countries more vu lnerable
to international interest rate shocks. In particular, a permanent increase in the real
interest rate at which a net debtor country can borrow abroad will reduce the country's steady
state level of national income and wealth. Moreover, if such an increase in the country risk
premium occurs abruptly, as is often the case, it may create a serious domestic recession in
the short run.
1. In an open economy which allows free international mobility of capital, part of domestic investment
may be financed by capital imports from abroad, and part of domestic saving may be
invested in foreign assets. It is then necessary to distinguish between the domestic capital
stock {the stock of capital invested in the domestic economy) and national wealth {the total
stock of assets owned by domestic residents). A country's stock of net foreign assets is equal
to the difference between its national wealth and the domestic capital stock.
2. In parallel to the distinction between the domestic capital stock and national wealth, one must
distinguisr between gross domestic product {GDP) which is the total output produced by the
factors of production employed in the domestic economy, and national income which is the
total income earned by the factors of production owned by domestic residents. National
income is equal to GDP plus the return to the country's net foreign assets.
3. The growth rate of a country's capital stock is given by its rate of domestic investment,
whereas the growth rate of national wealth is determined by the national savings rate. In a
closed economy saving and investment are identical and therefore perfectly correlated. In the
open ecoromy capital mobility reduces the correlation between saving and investment. The
current account on the balance of payments represents the difference between national saving and national investment. As an accounting identity, the increase in a country's net
foreign assets is given by the balance on its current account.
4. International capital mobility may take the form of international portfolio investment, where
households or institutional investors (including banks) acquire foreign assets to diversify their
portfolios, or it may take the form of foreign direct investment where the investor acquires a
controlling ownership share of foreign business assets. In recent decades both forms of
international investment have grown much more rapidly than world output and world trade, as
many governments have liberalized capital flows, and as improvements in information and
communication technologies have reduced the barriers to foreign investment. The growing
mobility of cap tal has caused a fall in the correlation between national rates of saving and
investment. In the euro area this correlation is now close to zero.
5. Capital is said to be perfectly mobile when domestic and foreign assets are perfect substitutes
and investors can instantaneously and costlessly switch between the two asset types.
In a small open economy which cannot affect the world interest rate or any other foreign
macroeconomic variable, perfect capital mobility implies that the correlation between national
saving and national investment tends to zero.
6. In our Solow model of a small open economy with perfect capital mobility, the domestic
capital intensity adjusts instantaneously to its steady state level determined by the international
interest rate. By contrast, national wealth per capita evolves gradually over time, since
any increase in wealth generates an increase in capital income, thereby raising aggregate
saving which in turn generates another increase in wealth, and so on.
7. The process of wealth accumulation in the small open economy is dynamically stable if and
only if the (effective) labour force grows at a rate exceeding the product of the savings rate
and the international real interest rate. When the labour force is measured in technologyadjusted
efficiency units, this stability condition will be met for all realistic parameter values.
8. By allowing free international capital flows, a country will be able to increase its national
income whenever the domestic steady state real interest rate in the absence of capital mobility,
r;, deviates from the world real interest rate, r. If r; > r, which will typically be the case in
a country with a relatively low savings rate, capital mobility benefits the domestic economy by
enabling firms to borrow at a world interest rate below the (initial) marginal return to domestic
investment. If r: < r, which will tend to be the case in a country with a relatively high savings
rate, domestic wealth owners gain because capital mobility allows them to invest their savings
at a higher (initial) rate of return abroad than at home. If wealth is unevenly distributed, capital
mobility will affect the distribution of income and may in fact hurt some domestic agents even
though it raises aggregate income.
9. While capital mobility enables domestic agents to take advantage of rate-of-return differentials
between the domestic and the foreign economy, it also makes countries more vu lnerable
to international interest rate shocks. In particular, a permanent increase in the real
interest rate at which a net debtor country can borrow abroad will reduce the country's steady
state level of national income and wealth. Moreover, if such an increase in the country risk
premium occurs abruptly, as is often the case, it may create a serious domestic recession in
the short run.
Comments
Post a Comment