Question

URGENT
1) Imagine that you run the Central Bank of India. Your goal is to stabilize income, and you adjust the money supply accordingly. Under your policy, what happens to the money supply, the interest rate, the exchange rate, and the trade balance in response to each of the following shocks? a. The Government raises taxes to reduce the budget deficit. b. The Government restricts the import of Japanese cars.

Answer 1

The Government raises taxes to reduce the budget deficit. Ms, IR, ER. trade balance.
- A budget deficit occurs when expenses exceed revenue and indicate the financial health of a country.
- In case of a recession, when the govt. raise taxes to reduce the budget deficit and increase revenue, spending would significantly fall due to which money supply would decrease in the market. more people would spend less and save more.
When it comes to the interest rate, lower it is, more people are willing to borrow money to make big purchases.
But, since there is a raise on taxes, people would spend less which would lead to higher interest rates. The central bank of India would increase the interest rate when inflation looks to rise above the inflation target so that itcan moderate the economic growth.
Higher interest rate leads to decrease inflationary pressures causing an increase in the exchange rates.
The trade balance is something when the country's imports and exports are well balanced, trade deficit means the import is higher than exports. That is what would happen when the central bank increases tax rates. over the period, when people would spend less, the country would soon fall short of things internally. This would lead to more borrowing fo goods from other countries. keeping the trade balance lower to the trade deficit.

Thus, when the central bank of India raises tax to reduce the budget deficit, it will affect by less spending, higher interest rates and short of money supply in the market, increase in exchange rates and lead to the trade deficit.

The Government restricts the import of Japanese cars
At present, the import of Japanese cars in the country would cost the total duty at around 180% of FOB (free on board) value from the Maximum retail Price.
- The restriction would significantly affect the Indian Automobile industry as it accounts for over 50% of the total numbers sold.
- Money Supply: It would significantly increase in the Indian market as there will not be any outflow of the money supply to japan, people would purchase within India.
- Interest rate: with higher demand and increasing spending within the car/automobile sector in India, the Interest rate would fall.
- Trade balance: Restrictions would cause more manufacturing, assembling within the country through existing companies in the short run and more new companies in the long run. Or look for other countries to import in the short run. However, Trade balance would go positive to trade surplus in the auto sector as import decreases significantly.
- Exchange rates : If the Buyer from India stops import/purchasing from japan and manufactures in the counrty or imports from other countries, the exhange rate would become stronger for the indian country. However, the exchange rate significantly depends on the US $ being the super power country.