The national government increases spending and lowers taxes in an effort to rais
ID: 1188680 • Letter: T
Question
The national government increases spending and lowers taxes in an effort to raise RGDP and lower the unemployment rate. However, the budget deficit is increased, so the treasury borrows funds to finance the higher deficit. The country has fixed exchange rates with the US dollar which the central bank maintains through aggressive intervention in the foreign exchange market.
A) Show the shift in AS or AD in the real goods market as a result of the change in G and T. Insert arrows to show the change in PI and RGDP.
B) PI (rises or falls) and RGDP (increases or decreases). The change in RGDP causes imports to (increase or decrease) and NE to (increase or decrease).
C) The change in PI causes exports to (rise or fall) which leads NE to (increase or decrease). The combined effect of PI and RGDP on NE causes the domestic currency to (appreciate or depreciate).
D) The change in R causes foreign money to flow (into or out of) the nation. This causes the domestic currency to (appreciate or depreciate). The effect of R opposes those of PI and RGDP. If capital mobility is low, the domestic currency will (appreciate or depreciate).
E) If the domestic currency depreciates, the central bank must purchase (dollars or pesos) to maintain the fixed exchange rate. This effect will (support or counter) the goal of stimulating the nation’s economy.
Explanation / Answer
a) Increase in government spending and decrease in taxes leads to increase in aggregate demand. This will shift AD curve rightwards. Thus increase in RGDP and price.
b) Both Price and RGDP rises as increase in AD leads to increase in price and output.. Increase in RGDP will increase imports as increase in income will lead to increase in demand of imports. This in turn will lead to decrease in net exports..
c) Price increase will decrease exports as demand of country's goods by world will decrease if it gets costlier. Thus net exports will decrease. Thus the combined effect of this is that domestic currency is depreciate.
d) Change in R causes foreign money to flow out of the nation. This causes the domestic currency to appreciate.
e) If domestic currency depreciates, the central bank must purchase pesos to maintain fixed exchange rate. This will support goal of stimulating nation's economy.