In many third world countries, foreign investors are concerned about whether the country’s government and firms...

In many third world countries, foreign investors are concerned about whether the country’s government and firms will repay their debts. As a result, foreign purchases of domestic assets depend not just on the domestic interest rate (r) but also on the government’s budget deficit (G − T). Specifically, a higher budget deficit reduces foreign purchases of domestic assets. Suppose the government in such an economy reduces government purchases . Assume that exchange rates are floating.

a. What happens to output, consumption and investment?

b. Can you tell what happens to the net capital outflow, net exports and exchange rate?

Expert Solution

Rahul Sunny answered 8 months ago

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