First of all have a look at a small open economy with perfect capital obility (chapter 1). For the small open economy, the foreign interest rate is given exogennously. And under perfect capital mobility, the domestic interest rate agrees with the foreign interest rate. Take for instance a Solow model featuring the dynamics of foreign assets. The income of domestic residents is composed of factor income and the interest inflow. Domestic residents save a fixed proportion of their income. The current account surplus is the sum of net exports and the interest inflow. The current account surplus in turn contributes to the accumulation of foreign assets. As a rule, the steady state will be stable. As an exception, however, if the rate of labour growth is very low, then the steady state will be unstable. And the same holds when the foreign interest raet (the saving rate, respectively) is very high.
KeywordsInterest Rate Wage Rate Labour Demand Saving Rate Labour Mobility
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