Consequences of Decline in Exports and rise in government spending
Consequences of Decline in Exports and rise in government spending
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belgmal · External communityPost link
External question — Economics Stack Exchange
Author: belgmal
Original post: https://economics.stackexchange.com/questions/60465
License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/
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In an open economy, a decline in incoming tourism occurs due to war (decline in EX).
The government does not want output (Y) to decrease, so it increases government spending (G).
Assuming the government achieves its goal and output remains unchanged, what can we conclude about:
1. The exchange rate (E)
2. The trade balance (NX = EX − IM)
3. The levels of investment (I) and consumption (C)?
So here is my analysis:
The decrease in tourism will lead to diminished demand for the local currency, hence E will rise (depreciation). Moreover the increase in G will provide (local currency) liquidation into the economy and thus E will rise even more.
the increase in G will lead to the rise of IM and we are given that EX is down. So we can conclude NX is down.
There will be no change in I and C because Y stays the same after the increase in G and the interest rate is unchanged
But according to my lecturer’s answers E is not supposed to change.
How’s that possible ?
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Pavan C. · External communityPost link
External answer — Economics Stack Exchange
Author: Pavan C.
Original post: https://economics.stackexchange.com/a/60484
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I'm assuming capital mobility (MF model or IS-LM-BP model). Government spending goes up, then rates locally go up due to crowding out (and increase aggregate demand as you showed), which results in capital inflows--this increases the foreigners demand for domestic currency, which increases the exchange rate as you said.
However, when exports decrease, foreigners demand less of the domestic currency (for the case of tourism: they are not visiting the country, so they wouldn't want our currency), so the exchange rate falls.
There are fighting effects, hence why your lecturer would say the effects cancel out.
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Quoted from Forex.com.bd-Editorial External question — Economics Stack Exchange Author: belgmal Source score (net votes, not local likes): 1 Original post: https://economics.stackexchange.com/questions/60465 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. In an open economy, a decline in incoming tourism occurs due to war (decline in EX). The government does not want output (Y) to decrease, so it increases government spending (G). Assuming the government achieves its goal and output remains unchanged, what can we conclude about: 1. The exchange rate (E) 2. The trade balance (NX = EX − IM) 3. The levels of investment (I) and consumption (C)? So here is my analysis: The decrease in tourism will lead to diminished demand for the local currency, hence E will rise (depreciation). Moreover the increase in G will provide (local currency) liquidation into the economy and thus E will rise even more. the increase in G will lead to the rise of IM and we are given that EX is down. So we can conclude NX is down. There will be no change in I and C because Y stays the same after the increase in G and the interest rate is unchanged But according to my lecturer’s answers E is not supposed to change. How’s that possible ?
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