Question

6.    Suppose an economy under fixed (pegged) exchange rates is currently facing:

1. a balanced current account (NX = 0),
   2. a negative output gap (excess unemployment), and
   3. a balanced budget.

1. Using an NX/ (S-I) model depict the above situation in relation to the internal and external balance diagrammatically.

2. Now suppose as an advisor to the government your recommendation is to employ an expenditure-changing policy to attain the Internal Balance. Explain in details what this policy is made up and what the consequences of your recommendations will be. Show diagrammatically and explain fully.

3. In light of your answer to part (b) would you agree with this statement? “A trade deficit and low savings go hand in hand.” Evaluate fully.

4. Defend this proposition “attaining the two policy objectives of internal and external balance requires two polices”. Explain and illustrate diagrammatically.

Answer 1