In a two-period model, as long as wealth effects are small, an increase in the world real interest rate

Question

Quizplus · Accepted Answer

In a two-period model, a higher real interest rate in the world leads to a higher return on savings. As a result, agents increase their savings in the current period in order to consume more in the future when the return is higher. Therefore, consumption decreases in the current period. This decrease in consumption leads to an increase in the current account surplus, as agents are consuming less and therefore importing less. The increase in saving could potentially lead to an increase in investment as well, but the question only specifies the effect on consumption and the current account surplus. So, the correct answer is A.

In a Two-Period Model, as Long as Wealth Effects Are