ECON 20 Lecture Notes - Lecture 27: Capital Accumulation, Macroeconomics, Potential Output
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● Borrowing in foreign currency is not a problem for the United States. The U.S. borrows
from other countries in its own currency, so it does not have debt in foreign currency. This
gives the U.S. an advantage. While the dollar may depreciate, the U.S. will still pay back its
debt in dollars, so the change in exchange rates will not affect its ability to service its
a. This point implies that the U.S. is unlikely to be face severe consequences from a
speculative currency attack.
b. If the concern is government debt, it’s clear that default is very unlikely. The federal
government can always create dollars to pay foreign debt so there the U.S.
government would never be forced to default. It would be a political mistake of huge
magnitude for Congress or the President to cause such a default.
c. Private U.S. debtors could default on debt obligations to foreigners, but in a crisis the
government always has the ability to “bail out” private debtors and prevent crisis-
i. Example: In the fall of 2008 during the “Great Recession” financial crisis, the
large U.S. insurance company AIG was in danger of not paying its debt
obligations. AIG owed the larger German institution Deutsche Bank a huge
amount of money. The U.S. Treasury and Federal Reserve arranged loans to
AIG to pay back its creditors, including Deutsche Bank. This was only
possible because AIG had dollar debts. If it owed euros, the U.S. government
could not have helped as easily.
c) Trade deficits and foreign saving
● As we have discussed, a trade deficit is “financed” by foreigners’ purchase of assets in the
country that runs the deficit. Thus, the deficit can be thought of as foreign saving flowing
into a deficit country.
● Let’s look at this relationship in more detail:
a. From the GDP equation: Output = Y = C + I + G + Ex – Im.
b. From our earlier discussion, we know that, aside from technical details, output is
conceptually equivalent to income: Y = Income.
c. Income can be used for three things: consumption, saving (S), or taxes (T), so:
Income = C + S + T = Y = C + I + G + Ex – Im.
d. Even though it is unrealistic, for now assume that the government runs a balanced
budget (we will consider government deficits later in the course). Then, G = T, so
those terms cancel from the equation above. We can also cancel the C terms from
both sides of the equation. This leaves S = I + Ex – Im or S + (Im – Ex) = I.