LECTURE 5:KEYNESIAN MULTIPLIERS

AND THE TRANSFER PROBLEM

• The multiplier for an increase in , e.g., due to a fiscal expansion .

X

A

• The multiplier for an increase in , e.g., due to a devaluation.• The Transfer Problem .

T

EU fiscal contraction has evidently been contractionary

Source: P.Krugman, 10 May 2012, via R.Portes, May 2013.

ΔG leads to both a fiscal deficit & trade deficit (US in 1980s & 2001-07).

But if the exogenous rise is ΔI, BD & TD move opposite directions (US 1990s).

“Twin deficits”:

ITF-220- Prof.J.Frankel, Harvard Kennedy School

ΔE shifts the X-M line up byΔX, the elasticities answer.But the rise in TB is partially offset by higher imports.

SUMMARY OF MULTIPLIERS

MX I NS

ms

MXA Y

G I CA where

Ams

1 Y

Ym- ΔM ΔTB

+ Keynesian model of S + M =>

Fiscal Expansion

open-ec. multiplier = 1/(s+m)<1/s

YmXΔ ΔTB

Xms

1 Y

Devaluation

Note misprint in Equation (17.11).,10th ed. of WTP.)

. AΔms

m

XΔ

ms

s

. XΔ

ITF-220- Prof.J.Frankel, Harvard Kennedy School

The Transfer ProblemThe Question: If one country makes a unilateral transfer

ΔT to the other, does the recipient buy enough goods from the transferor so that the latter’s ΔTB

• falls short of the transfer ? => ΔTB - ΔT < 0 => “transfer is under-effected” => CA ↓ .

• exceeds the transfer ? => ΔTB - ΔT > 0 => “transfer is over-effected” => CA ↑ .

• equals the transfer ? => ΔTB - ΔT = 0 => “transfer is fully effected” => ΔCA = 0 .

The US TB improved in the late 1980s, due to $ depreciation and especially, in 1990-91, US recession.

The current account even went into surplus briefly in early 1991.

Why? Transfers received from Kuwait, Saudi Arabia, et al.

ITF-220- Prof.J.Frankel, Harvard Kennedy School

ITF-220- Prof.J.Frankel, Harvard Kennedy School

End of Lecture 5: Keynesian Multipliers

andthe Transfer Problem

in a Small Country