How does an increase in government purchases financed by an increase in the deficit affect exchange rates? Support your answer with graphs of the loanable funds market and the foreign exchange market
What will be an ideal response?
An increase in government purchases financed by an increase in the deficit will reduce the supply of loanable funds, thereby increasing the interest rate. The increase in the interest rate will increase the demand for dollars (as capital inflows increase) and reduce the supply of dollars (as capital outflows decrease). Both the increase in the demand for dollars and the decrease in the supply of dollars will increase the equilibrium exchange rate, as shown below.
You might also like to view...
The short-run demand curve for labor for a firm in any type of market for its output coincides with
a. the upward sloping portion of the marginal revenue product curve. b. the downward sloping portion of the marginal revenue product curve. c. the downward sloping portion of the marginal product curve. d. the marginal labor cost curve.
Suppose the demand for barley is perfectly elastic. The supply curve of barley is upward sloping. If a tax is imposed on barley,
A) barley sellers pay the entire tax. B) barley buyers pay the entire tax. C) the government pays the entire tax. D) the tax is split evenly between barley buyers and sellers. E) who pays the tax depends on whether the government imposes the tax on barley sellers or on barley buyers.
A lower interest elasticity of investment demand leads to a
a. steeper IS curve. b. flatter IS curve. c. steeper LM curve. d. flatter LM curve.
Which of the following is included in M2? I. money market mutual funds II. small-denomination certificates of deposit
A) I only B) II only C) Both I and II D) Neither I nor II