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Integrated Markets Part IV. Feldstein-Horioka. Saving = Investment. Elementary macroeconomics tells us that the above must be true More advanced economics keeps this equality but modifies it with realistic additives like the current account and the government budget (Ex – Im and G – T).

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Integrated markets part iv l.jpg

Integrated MarketsPart IV

Feldstein-Horioka


Saving investment l.jpg
Saving = Investment

  • Elementary macroeconomics tells us that the above must be true

  • More advanced economics keeps this equality but modifies it with realistic additives like the current account and the government budget (Ex – Im and G – T)


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Digression on Why

  • Advanced macroeconomics presents the elementary I = S as the more complicated

  • I + G + Ex = S + T + Im

  • Consumers (general public) may produce all of GDP, but they purchase only about 2/3


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First I + G + Ex

  • These are non-consumer components of total demand: investors (businesses) buying their machines & other items; the government buying its energy, education, infrastructure; foreigners buying our exports


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NowS + T + Im

  • This is a supply concept

  • The three terms add up to be components of GDP not purchased by consumers

  • But consumers (general public) produced these components

  • By not purchasing them, they “supply” these goods for others


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In Other Words

  • GDP = Gross Earned Income = C + S + T + Im

  • C is spent on consumption

  • S + T + Im is money not spent (goods not purchased), but the money goes to financial institutions, the government and to foreigners


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Finally

  • Financial institutions lend the money to consumers, the government & business

  • The government transforms its share (T) into spending (G)

  • Foreigners use the money to spend or invest in our country (Ex or capital inflow)


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Saving  Investment

  • In a relatively closed economy, S & I normally rise & fall together: S  I

  • In an open economy, this link is broken: S  I

  • Big saving countries lend to low savers


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Some Macroeconomics

  • S – I = G – T + Ex – Im

  • = G – T + CA

  • = G – T – KA

  • So, S + KA – I = G – T

  • Whatever fiscal policy may be (G – T), saving & investment are separated by capital account


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S + KA – I = G – T

  • If G – T  0, a low saving country with good investment possibilities will have a capital inflow (KA > 0)

  • If G – T is large & positive (deficit), KA will be correspondingly large & positive (USA)

  • Japan? Vietnam? Korea?


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Final Note

  • These four market standards actually fail to indicate much integration beyond the fairly tight relationship between USA and Japan

  • Not even USA & most European countries


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