True or False.
The answer is True. An upward shift of savings will increase the excess of savings over investment and reduce aggregate demand, income, and the level of employment. This will moderate the initial increase in savings and eliminate some of the excess of savings over investment. It will also reduce imports, raising the trade balance to accommodate a higher level of savings minus investment and the net capital outflow than had initially been occurring. An upward shift of exports will increase the trade balance and create excess aggregate demand. This will cause output and employment to rise, moderating the increase in the trade balance and increasing savings minus investment to bring the net capital flow into line.
Again recall Equation 1 and its extension, Equation 10.
1. S − I = BT + DSB
and its extension, Equation 10
10. ΦS-I + s Y + μ r* = ΦBT − m Y + m* Y* − σ Q + DSB
An upward shift of savings represents an increase in ΦS-I which raises the left side of the two equations. Since Q cannot change, Y has to fall to increase the right side. As that happens, the increase in savings is moderated and the left side declines toward its initial position. Equilibrium is thus achieved by an increase in the right side combined with a fall-back of the left side part way toward its initial position.
An upward shift of exports, represented by an increase in ΦBT , increases the right side of Equations 1 and 10. Y must rise to increase the left side to preserve equilibrium. As Y rises, imports increase and the right side falls back toward its initial position. Equilibrium occurs when equality between the two sides has been reestablished.