Question

US income growth slowed to 2.7% from 5.3% in the previous quarter. The 2.7% came in well below the forecasted 3.5%.” Assume Hong Kong and the US are on a fixed exchange rate regime, while the US and Europe are on a flexible exchange rate regime. As income growth in the US decelerates, what do you expect to happen to

a) The US trade balance with Hong Kong?

Answer 1

Ans (a)

The fixed exchange rate regime means the country has tied the value of its currency to some other popularly used commodity or currency.

The government can follow the monetary policy and fiscal policy in fixed exchange rate regime inorder to regulate the economy.The impact of  monetary policy is ineffective under fixed exchange rate regime due to which income and net exports are unaffected under this.So when the net exports which is the difference between the exports and imports are unaffected then the US trade balance with Hong Kong is also unaffected since the trade balance is affected by the net exports.

The impact of fiscal policy in fixed exchange rate regime due to which the income level of people increases whereas the net exports is unaffected since the net exports is unaffected under this the US trade balance with Hong Kong is also unaffected since trade balance is affected by the net exports.

As per the above explanations it can be concluded that the US trade balance with Hong Kong will be unaffected under both the monetary and fiscal policy adopted by the government under fixed exchange rate regime.