Problem set: Exchange rates and open-economy macroeconomics.
As such what can be expected is “a temporary increase in fiscal expansion and rise in output thereby resulting into currency appreciation.”3 But when it is a permanent tariff, initially one can expect an aggressive movement in the market resulting into employment. However, in the long- run, “output returns to its initial level and all money prices rise in proportion to the increase in money supply.“
2. Suppose there is a permanent fall in private aggregate demand for a country’s output (a downward shift of the entire demand schedule). What is the effect in the output? What government policy response would you recommend?
If there is a permanent fall in private aggregate demand for a country’s output, there will be an increase in the supply of the output thereby lowering the price of the goods and services which posits a big problem to investors and the government. For such a scenario will possibly lead to bankruptcy of industries resulting into unemployment, which is what we, are all avoiding. In a situation like this, I think what the government should do is to increase government spending in order to prop up the economy. But this should be only temporary until an equilibrium has been established since we do not want to have a “crowding out” to happen to the country’s output for that may further aggravate the permanent fall in aggregate demand for a country’s output. At the same time, I will impose import tariffs in order to protect the domestic economy. It is indeed protectionism but I honestly think that such a scenario demands an aggressive response from the government.
Current account balance (CA) is “the demand for the country’s exports less that country’s own demand for imports is determined by two main factors: the domestic currency’s real exchange rate against foreign currency and domestic disposable