Macroeconomics
10th Edition
ISBN: 9781319105990
Author: Mankiw, N. Gregory.
Publisher: Worth Publishers,
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Question
Chapter 13, Problem 7PA
To determine
The short run impact of a tax cut in a small open economy on the exchange rate and income under two exchange rate systems.
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Let S be the USD/GBP exchange rate, P∗ be the pound cost of a consumption basket in the U.K., and P be the dollar cost of a consumption basket in the U.S. Using the units of S, P∗, and P, find the units of the real exchange rate, Q = SP∗/P
Consider the following open economy. The real exchange rate is fixed and equal to one. Consumption,investment, government spending, and taxes are given by:C = 8 + 0.6(Y - T), I = G = T = 0.Imports/ exports are given by:Q = 0.4Y, X = 0.4Y*,where an asterisk denotes a foreign variable.
if the domestic government increases spending by 6 units as in b) and G=0in the foreign country, the equilibrium output in the domestic country increases by units, and the trade balance in equilibrium is
Now, suppose that the two countries coordinate in their fiscal policy. Both countries set atarget level of output of 30 and agree to increase G at the same amount. The common increase in Gnecessary to achieve the target output is and the trade balance is
Consider the following open economy. The real exchange rate is fixed and equal to one. Consumption, investment, government spending, and taxes are given by:C = 8 + 0.6(Y - T), I = G = T = 0.Imports/ exports are given by:Q = 0.4Y, X = 0.4Y*,where an asterisk denotes a foreign variable
a. If the domestic government increases spending by 6 units (i.e., G increases from 0 to 6), the equilibrium output in the domestic country will increase by ____. and the trade balance will ________ (increase/decrease) by _____.
b. Assume the foreign economy has the same equations as the domestic economy. Both governments consider the impact of the other country on the domestic economy. If the domestic government increases spending by 6 units as in b) and G=0 in the foreign country, the equilibrium output in the domestic country increases by _______ units, and the trade balance in equilibrium is _____.
c. Please compare answer a) and b) regarding the equilibrium output and explain the difference.
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- Consider the following open economy. The real exchange rate is fixed and equal to one. Consumption,investment, government spending, and taxes are given by:C = 8 + 0.6(Y - T), I = G = T = 0.Imports/ exports are given by:Q = 0.4Y, X = 0.4Y*,where an asterisk denotes a foreign variable.Question Following a), if the domestic government increases spending by 6 units (i.e., G increasesfrom 0 to 6), the equilibrium output in the domestic country will increase by unitsand the trade balance will (increase/decrease) by units. Question c): Assume the foreign economy has the same equations as the domestic economy. Bothgovernments consider the impact of the other country on the domestic economy. If G=0, then theequilibrium output in both countries is and the trade balance is Following c), if the domestic government increases spending by 6 units as in b) and G=0in the foreign country, the equilibrium output in the domestic country increases by units, and the trade balance in equilibrium is…arrow_forwardSuppose a small open economy has the following money demand function: M/P = L (r, Y-T), where r is the interest rate and (Y-T) is the disposable income. Please illustrate graphically the short-run impact of a tax cut on the exchange rate and level of output in the small open economy under both fixed and floating exchange rate systems. Be sure to label: i. the axes, ii. the curves, iii. the initial equilibrium levels, iv. the direction the curves shift, and v. the new short-run equilibrium.arrow_forwardSuppose the Central bank declares an increase in Statutory Liquidity Ratio as well as CRR. What will be the impact of this policy on net exports of the country under a flexible exchange rate regime?arrow_forward
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- Identify two factors (or characteristics of economy) that underlie a nation’s decision to adopt a fixed exchange rate or a floating exchange rate.arrow_forwardRelative inflation rates affect interest rates, exchange rates, the overall economic health of a country, and the operations and profitability of multinational companies. Consider the following statement: Countries with lower inflation rates will have lower interest rates. Based on your understanding of the relationship between relative inflation rates and exchange rates, identify whether the preceding statement is valid or invalid. The statement is invalid, because the nominal interest rate is independent of the inflation rate. The statement is valid, because the nominal interest rate is the sum of the real interest rate plus inflation, so lower inflation rates would result in lower interest rates.arrow_forwarda) If the interest rate in the United Kingdom is 8%, the interest rate in the U.S. is 10%, and the spot exchange rate is 1.35 dollar per pound. If interest rate parity holds, what is the expected future exchange rate? b) Alternatively, using the same interest rates as above, suppose the expected future exchange rate is 1.35 dollar per pound. What is the spot exchange ratearrow_forward
- If the interest rate in the United States rises, A) investors increase their demand for dollars and the U.S. exchange rate appreciates B) investors increase their demand for dollars and the U.S. exchange rate depreciates C) investors decrease their demand for dollars and the U.S. exchange rate appreciates D) investors decrease their demand for dollars and the U.S. exchange rate depreciates> (Please note that D is already incorrect)arrow_forwardUnder a fixed exchange rate regime, the value of the currency is pegged to a specific currency. This provides stability and predictability for international businesses when engaging in cross-border transactions and making long-term investment decisions. Companies can better plan and forecast their international operations without worrying about sudden exchange rate fluctuations. Businesses with significant cross-border trade and investment activities can benefit from reduced currency risk as their transactions are shielded from short-term volatility in exchange rates. This can be particularly advantageous when dealing with countries with historically unstable currencies. Fixed exchange rates can act as a constraint on monetary policies, preventing excessive money supply growth that may lead to inflation. This can create a more stable economic environment for businesses to operate in. In a floating exchange rate system, currency values are determined by market forces, primarily supply…arrow_forwardThe spot exchange rate between the dollar and the Swiss franc is a floating, or flexible, rate. What are the effects of each of the following on this exchange rate? There is a large increase in Swiss demand for U.S. exports as U.S. culture becomes more popular in Switzerland. There is a large increase in Swiss demand for investments in U.S. dollar-denominated financial assets because of a Swiss belief that the U.S. economy and political situation are improving markedly. Political uncertainties in Europe lead U.S. investors to shift their financial investments out of Switzerland, back to the United States. U.S. demand for products imported from Switzerland falls significantly as bad press reports lead Americans to question the quality of Swiss products.arrow_forward
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