An Interest Rate Shock and the Behavior of a Small Borrowing Economy

Abstract

For those industrializing countries which borrow from abroad

mainly for investment purposes, investment decision is not passive

as predicted by the one-sector growth models. Using the

Blanchard-Fischer model with installation costs of investment

which separate investment decision from saving decision, we

analyze the impacts of the world interest rate shock and show

that a drop in the world interest rate cannot always be taken as

a favorable shock to the small borrowing economy. While the

lower interest rate increases the external debt due to active

investment, it can increase or decrease consumption.