Question: In an open economy, there are three sources of funds to finance investment private savings (Sp), government savings (the difference between government revenues and expenditures, Se), and foreign borrowing, B:
l= Sp + Sg + B.
a. Suppose a certain country has private savings of 6 percent of GDP, foreign borrowing of 1 percent of GDP, and a balanced budget. What is its level of investment?
b. Suppose now that the government runs a deficit of 3 percent of GDP, and investment and private savings remain unchanged. What must happen to foreign borrowing?
c. Suppose now that the government runs a deficit of 3 percent of GDP, and this increases the interest rate. If this in turn leads to increased private savings, to 7 percent of GDP, and reduced investment from 7 percent to 6 percent of GDP, what happens to foreign borrowing?