Assignment 6 International Macroeconomics

Prévia do material em texto

Assignment 6: the open economy
Answer the following questions using appropriate equations and diagrams
If domestic inflation exceeds foreign inflation, how do domestic net exports react if the nominal exchange rate is fixed?
The equation of exports relative to the incomes and the real exchange rates has to be used:
X = X(Y* (+), e (+))
X is the exports, Y* is the foreign incomes and e is the real exchange rate. 
E is define as the price of foreign goods relative to the prices of domestic goods. It means that an increase in e reflect that domestic goods are more competitive. Thus, if the domestic inflation is higher, the competitiveness of the domestic goods will decrease. The result will be observed as a decrease in the domestic exports. 
Demonstrate the impact of a decrease in domestic taxes on real GDP and trade balance.
The equation below expose the components of internal demand: 
D = C + I + G = C(Y – T) + I(Y, r) + G
C is the consumption depending on Y (incomes) and T (taxes). If taxes decreases, the consumption will increase and so will the demand. 
On the graph below, we can observe the impact of this fact on the real GDP and the trade balance.
The increase in the internal demand will result in an increase in GDP. However, the effect on the trade balance is different. The AA curve below which represents the evolution of the demand of domestic goods and increase slowly compared to the DD curve that represent the domestic demand. This is due to the fact that the demand of imported goods will increase and so will the value of all imported goods in the domestic demand. The exports are not linked to the domestic demands so they will not be modified by an increase in GDP. This will make the trade balance decrease. If the real GDP is higher than the crossing point of the ZZ curve and the DD curve, the trade balance would be negative. 
Demonstrate how a budgetary contraction can eliminate trade deficit, at the cost of lower economic growth
In order to eliminate trade deficit, the equilibrium point (when the ZZ curve cross the black curve) has to be inferior to the crossing point of the ZZ and DD curves. Y* has to be smaller than Y2. In order to do so, internal demand has to be decreased. This will move the ZZ curve down and thus moving the equilibrium point to the left. This operation has to be done until the GDP of the Y2 position is equal to the real GDP of the equilibrium point. 
What policy has the largest expansionary effect in the short run: an increase in government expenditure (G), or a decrease in corporate taxes (T)?
In the short run, an increase of the government expenditures has more effect. The money will be directly injected in the economy. It will increase GDP to an amount superior of the sum spent due to the multiplier effect. On the other hand, if the corporate taxes are reduced, companies can also choose not to invest the total amount of money if the market is not showing signs good enough. 
Consider two large Eurozone economies (A and B). A is experiencing a permanent trade deficit and B is experiencing a permanent trade surplus:
Using appropriate diagrams, demonstrate how a government-induced contraction in country A could eliminate trade imbalances (i.e. bring net exports to zero)
As shown on the diagram above, a contraction in the country will lead to a decrease in demand. This decrease in demand in country A will decrease the demand for imported goods from country B. It will not modify the amount of goods that B is importing from A. Thus, this will lead A to reduce its deficit and as A will decrease its importations from B, the trade surplus of B will disappear. This is done without taking into account the effect of the rest of the world. 
Using appropriate diagrams, demonstrate how a government-induced expansion in country B could also eliminate trade imbalances (i.e. bring net exports to zero)
Using the same diagram as question a and the equation below, the government expansion will result in an increase in G. 
D = C + I + G 
This will result in an increase of internal demand. This increase of the internal demand will result in an increase in imported goods from country A but the exports of A from B will not increase. The ZZ curve of country B will go up on the diagram. This will result in an elimination of trade imbalances. 
What lessons could be drawn for plans to restore macroeconomic stability in the Eurozone?
We can say that in order to set economic stability in Europe, the countries with high trade balance can increase government spending and the countries with deficit in their trade balance should have a voluntary contraction policies. Both methods are efficient and the use of the two will lead to higher efficiency. 
During the 1980-1985 period, the conservative US Reagan administration implemented several tax cuts as part of a ‘neoliberal’ policy platform. During the same period, the US trade deficit increased massively, to reach 40 billion US dollars in 1985. Are these two events related?
These two events are totally related. The equation below show that and decrease in taxes will increase consumption and then increase internal demands. The demand for imported goods has increased and not the amount of exports, which is not correlated with the internal demand. Thus the trade balance has decreased and the deficit was created.
Compare the US 1980-1985 experience with the French 1981-1983 experience. 
The French decision was to increase government spending a lot in order to increase growth and employment. The increase of government spending (G) caused the same effects than the decrease of taxes in the US. It caused an increase in the internal demand. It increased demand for imported goods and thus created a big trade deficit. In the case of France, the government had to go back on these measures in order to stay in the EMS system with the other European countries. 
Determine whether the following sentences are correct, incorrect or undetermined:
Trade deficits always reflect high investment levels. 
This sentences is false because, as seem above, trade deficit can be the consequences of many different factors and not necessarily high investment. However, a big increase in the investment can lead to trade deficit. Every factors that increase the internal demand (D) have an impact on the trade deficit. 
D = C + I + G = C(Y – T) + I(Y, r) + G
The trade deficit also depend on the economic policies of the others countries and about their trade balances. 
Government deficits generate trade deficits
A government deficit doesn’t always result in a trade deficit. Government deficit is the consequence of an increase in G or a decrease in taxes. This will have the effect of decreasing the trade balance. It could generate trade deficit but not in case of trade deficit of other countries or favorable market. 
It is easier for policy makers in a small open economy to achieve a given GDP target than it is for policy makers in a large open economy
This sentence has some true elements and wrong elements. In a small open economy, the countries can easily create coordination and common economic policies that would beneficiate for all but they will have less financial power to use. In a big open economy, they have more countries and so more difficulties for coordination but also more financial power. 
The only way to reduce a country’s trade deficit is to depreciate its national currency
This is false. A trade deficit can be reduce through an austerity policy or by a government-induced expansion in another country which is a trade partner.
When the trade balance is in equilibrium (i.e. net exports = 0), internal demand and the demand for national goods are equal.
This sentence is true as shown on the diagram below. The real GDP at the intersection between the DD (internal demand) curve and the ZZ (demand for domestic goods) is the real GDP for which the tradebalance is neutral.