Question

a.) Moldavia, an open economy currently in long-run macroeconomic equilibrium, has become concerned about its debt levels and the effects those levels might have on its international financial position. The Moldavian parliament decides to implement austerity measures to bring those debt levels down.


Suppose the country cuts government spending to reduce its deficit, and this policy reduces the risk premium on Moldavian assets. Economists also note that in the new long-run equilibrium, the quantity of national savings stays the same.  

Construct a well-labeled, three-panel diagram (the "trifecta") to analyze the impacts of this policy on the Moldavian economy. The supply curve for loanable funds in Moldavia is upward-sloping; the demand curve for loanable funds in Moldavia is downward-sloping.

Specifically, what happens to the following variables in Moldavia as a result of this policy:


*The real interest rate
*The real exchange rate
*The quantity of net exports
*The quantity of domestic investment

(iii) From your results in (a) above, investment in Moldavia _____ , thus _______ the growth rate of real GDP ( Y ) in Moldavia.

A. Increases ; lowering

B. Increases ; raising

C. Decreases ; lowering

D. Decreases ; raising

Answer 1

Ans.

Above shows the 3 panel diagram (the trifecta)

Explanation-

Suppose an economy exist as economy N, Now, suppose when the country N starts to cut there govt. spending to help reduce the deificit. The policy which is introduced here will help reduce the risk premium of there (Country N's) asset.

When the government spending drops or decreases , this leads to demand for loanable funds to reduce.

Suppoe that the country is facing a budget deficit . Now this budjet deficit will lead the supply of loanable funds to reduce.

Decrease in Interest rate will be the result. Growth of increase in domestic investment will happen and which will make other countries people will start withdrawing from the market (Domestic country). This would result in Capital outflow.

The lowering or decrease in interest rate will cause increase in quantity of the domestic investment.

When the capital outflow grows , then as a result it increases the supply of money(currency). And this increase supply causes depreciation in real exchange rate of that currency.

Correct Option will be B. Increases ; raising