LECTURE 5: KEYNESIAN MULTIPLIERS

AND THE TRANSFER PROBLEM

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

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

• The Transfer Problem, e.g., due to a unilateral transfer 𝑇 .

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

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 in 1990s).

“Twin deficits”:

𝑨 ↑, e.g., due to fiscal stimulus: 𝑮 ↑. Fiscal multiplier

Example: EU fiscal austerity has been contractionary.

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

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

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

𝑿 ↑, e.g., due to a devaluation: 𝑬 ↑. Export multiplier

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 Problem

The 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 .

Historical examples: Applications of the transfer problem

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

FIGURE 17.3

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

End of Lecture 5: Keynesian Multipliers

and the Transfer Problem

in a Small Country