Question

Please read the following short case carefully and provide your answer after analyzing question based on the appropriate open market models/diagrams.

Case: Offshore Outsourcing and Imports

Imagine that you are an economist working for the Congressional Budget Office (CBO). You receive a letter from the chair of the Senate Budget Committee:

Dear CBO economist,

Congress is about to consider the president’s request to cut our country’s offshore outsourcing by 50 percent and imports of durable goods by 40 percent. Before deciding whether to endorse the request, my committee would like your analysis. I wonder if you would advise us:

1. How cutting offshore outsourcing and imported durable goods will affect the domestic investment, domestic interest rate, NCO, exchange rate, and net export in our country?
2. What do you think will happen to real GDP, unemployment, and the price level in our country?
3. Is there any chance of this new policy to trigger stagflation in our economy? In case, if that happens, what kind of coordinated fiscal and monetary policy would be recommended to change the situation?

Sincerely

Committee Chair

Please do not plagiarize or copy-paste from other sources.

Answer 1

a. Domestic investment will increase because of this cut off as the money which was spent importing products and employing people overseas will be spent in the domestic economy.

Domestic interest rates might increase as there will be higher investment for which firms will borrow more and there will be higher demand for credit.

Net capital outflow will reduce as the country is focusing on domestic economy and will spend less overseas.

Exchange rate will gain in value and appreciate as imports decline.

Net export will be the same or increase slightly as investment will increase exports but with appreciation in the currency, exports turn out to be expensive and domestic producers earn less which will reduce net exports in the long run.

b. Real GDP will inch higher as domestic investment starts to pick up, unemployment will decline as more and more people will be employed and this will increase inflation in the economy as consumers start to demand more goods, this will impact the Nominal GDP which will turn out to be higher because of inflation, but the Real GDP will stay the same or increase slightly.

c. Yes, there is a chance if the demand starts to increase a lot and with that the wages increase, which will lead to higher unemployment rates, which is stagflation-higher inflation and higher unemployment rate. There needs to be coordinated fiscal stimulus wherein government increases supply and helps reduce cost of production. In terms of monetary policy the MPC will reduce the money supply by increasing the interest rates so that people start to save more and not spend, this will bring inflation in line and increase employment.