LECTURE 5: KEYNESIAN MULTIPLIERS AND THE TRANSFER PROBLEM The multiplier for an increase in, e.g., due to a fiscal expansion. The multiplier for an increase in, e.g., due to a devaluation. The Transfer Problem.

EU fiscal contraction has evidently been contractionary Source: P.Krugman, 10 May 2012, via R.Portes, May 2013.

ITF-220- Prof.J.Frankel, Harvard Kennedy School Δ G leads to both a fiscal deficit & trade deficit (US in 1980s & ). But if the exogenous rise is Δ I, 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 + Keynesian model of S + M => Fiscal Expansion open-ec. multiplier = 1/(s+m)<1/s Devaluation Note misprint in Equation (17.11).,10 th ed. of WTP.)

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.

The US TB improved in the late 1980s, due to $ depreciation and especially, in , US recession. The current account even went into surplus briefly in early Why? Transfers received from Kuwait, Saudi Arabia, et al.

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

End of Lecture 5: Keynesian Multipliers and the Transfer Problem in a Small Country