Could someone please clarify this for me? Solution to Decision # 4, mentions that “Country E’s currency will depreciate because the country has a savings surplus”. I am confused here. Isn’t it a positive sign that there exists a savings surplus and the country doesn’t have to borrow additional foreign debt? Moreover, Country E in this example has a higher trended growth rate indicating capital inflows into the country. So how is that the savings surplus will lead to a depreciated currency? Am I missing something here? Could someone please clarify? Thanks a lot. CS
According to this model, for the economy to grow, capital investment has to increase, the first source for this increase will be existing savings, if savings are not enough to support the continuted growth, capital will flow from outside, increasing the demand for the domestic currency and eventually it will appreciate. The opposite happens when the economy slows, savings will increase (lack of investment opportunities), capital will flow out (looking for growth elsewhere) and the currency will depreciate. Bottom line, if the savings can’t be invested (i.e. savings surplus) this means the economy is slowing.
Thanks a lot mo34. This surely clarifies it. CS.