Question

In: Economics

Case I: Offshore Outsourcing and Imports Imagine that you are an economist working for the Congressional...

Case I: 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 for 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?

Solutions

Expert Solution

a. By cutting offshore outsourcing and import of durable goods domestic investment will rise as firms and governments will try to replace the decline in imports by producing domestically and improving infrastructure.

Domestic interest rates will rise as domestic investment will give rise to increase in demand for credit from banks.

Net capital outflows will decline as the country will invest domestically.

Exchange rate would appreciate as imports will decline which will appreciate the domestic currency, because demand for domestic currency will rise and there will be fall in demand for foreign currency.

Net exports would increase or stay the same as imports would decline and because of investments, exports would rise but over the long run because the currency will appreciate, exports will turn out to be expensive and decline, which will reduce net exports.

b. Real GDP will increase as domestic output will increase. Unemployment will reduce and price level will increase as more and more people start to earn and demand more.

c. Yes, there is a high likelihood for this policy to trigger stagflation as price level will increase because of increase in demand as more and more people start to earn and spend, this will increase the wages and cause unemployment rates to rise. Thus there will be stagflation wherein the inflation and unemployment both will rise. Fiscal policy in terms of increase in government expenditure to increase supply and reduce cost of production, will lead to increase in employment and monetary policy reducing the money supply by increasing the interest rates will reduce the inflation rate as more and more people will start to save and spend less.


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