Macroeconomics

‭Infow, Outfows, and Restrictions‬ ‭In‬ ‭times‬ ‭of‬ ‭inflation‬ ‭for‬ ‭example,‬ ‭central‬ ‭banks‬ ‭or‬ ‭the‬ ‭Fed‬ ‭can‬ ‭implement‬ ‭a‬ ‭contractionary‬‭monetary‬ ‭policy‬ ‭to‬ ‭reduce‬ ‭aggregate‬ ‭demand‬ ‭and‬ ‭the‬ ‭demand‬ ‭for‬ ‭imports.‬‭This‬‭requires‬‭an‬‭increase‬‭in‬‭interest‬ ‭rates that results in the following chain of events:‬ ‭Interest‬‭rates‬‭↑‬‭→‬‭money‬‭supply‬‭↓‬‭→‬‭cost‬‭of‬‭borrowing‬‭↑‬‭→‬‭consumption‬‭↓‬‭→‬‭aggregate‬‭demand‬‭↓‬‭→‬ ‭demand for imports ↓ → net exports ↑ → current account defcit ↓‬ ‭However, this policy may not be effcient due to the following reasons:‬ ‭ ➔ ‬ ‭Higher‬ ‭interest‬ ‭rates‬ ‭(return‬ ‭on‬ ‭investment)‬ ‭attract‬ ‭foreign‬ ‭investments‬ ‭and‬ ‭promote‬ ‭capital‬ ‭inflows‬ ‭of‬ ‭hot‬‭money,‬‭which‬‭is‬‭the‬‭capital‬‭transferred‬‭between‬‭fnancial‬‭institutions‬‭in‬‭order‬‭to‬ ‭increase interest or capital gain.‬ ‭ ➔ ‬ ‭This‬‭increases‬‭the‬‭demand‬‭for‬‭the‬‭domestic‬‭currency‬‭because‬‭of‬‭increased‬‭foreign‬‭demand‬‭for‬ ‭domestic fnancial assets and investment.‬ ‭ ➔ ‬ ‭A currency appreciation may worsen the current account defcit instead of reducing it.‬ ‭The‬ ‭overall‬ ‭effect‬ ‭of‬ ‭this‬ ‭policy‬ ‭is‬ ‭indeterminate‬ ‭because‬ ‭it‬ ‭depends‬ ‭on‬ ‭whether‬ ‭the‬ ‭decrease‬ ‭in‬ ‭consumption‬ ‭is‬ ‭smaller‬ ‭or‬ ‭greater‬ ‭than‬ ‭the‬ ‭increase‬ ‭in‬ ‭the‬ ‭capital‬ ‭inflows‬ ‭caused‬ ‭by‬ ‭higher‬ ‭interest‬ ‭rates.‬ ‭Capital‬ ‭inflows‬ ‭and‬ ‭outflows‬ ‭in‬ ‭the‬ ‭loanable‬ ‭funds‬ ‭market‬ ‭are‬ ‭key‬ ‭factors‬ ‭in‬ ‭analyzing‬ ‭the‬ ‭effects‬ ‭of‬ ‭economic‬ ‭policies‬ ‭on‬ ‭the‬ ‭exchange‬ ‭rate.‬ ‭For‬ ‭instance,‬ ‭when‬ ‭capital‬ ‭inflows‬ ‭increase,‬ ‭the‬ ‭supply‬ ‭of‬ ‭loanable‬ ‭funds‬ ‭rises,‬ ‭leading‬ ‭to‬ ‭a‬ ‭drop‬ ‭in‬ ‭domestic‬ ‭real‬ ‭interest‬ ‭rates.‬ ‭This‬ ‭makes‬ ‭domestic‬‭fnancial‬ ‭assets‬ ‭less‬ ‭attractive‬ ‭to‬ ‭foreign‬ ‭investors,‬ ‭who‬ ‭then‬ ‭seek‬ ‭higher‬ ‭returns‬ ‭through‬‭foreign‬‭investments.‬ ‭Consequently,‬‭the‬‭demand‬‭for‬‭the‬‭domestic‬‭currency‬‭decreases,‬‭while‬‭its‬‭supply‬‭increases‬‭as‬‭residents‬ ‭exchange it for foreign currencies.‬ ‭Fiscal Policy‬ ‭Fiscal‬‭policy‬‭targets‬‭aggregate‬‭demand‬‭to‬‭cause‬‭changes‬‭in‬‭the‬‭price‬‭and‬‭output‬‭levels‬‭in‬‭an‬‭economy.‬ ‭These changes also impact the exchange rate.‬ ‭For‬ ‭instance,‬ ‭the‬ ‭government‬ ‭might‬ ‭attempt‬ ‭to‬ ‭reduce‬ ‭a‬ ‭current‬ ‭account‬ ‭defcit‬ ‭on‬ ‭the‬ ‭balance‬ ‭of‬ ‭payments by increasing tax rates. This will result in the following chain of events.‬ ‭Income‬ ‭tax‬ ‭and/or‬ ‭corporate‬ ‭tax↑‬ ‭→‬ ‭disposable‬ ‭incomes‬ ‭and/or‬ ‭investment‬ ‭↓‬ ‭→‬ ‭consumption‬ ‭↓‬ ‭→‬ ‭demand for imports ↓ → net exports ↑ → current account defcit ↓‬ ‭Unlike‬‭monetary‬‭policy,‬‭this‬‭policy‬‭does‬‭not‬‭affect‬‭the‬‭exchange‬‭rate‬‭negatively‬‭because‬‭the‬‭increase‬‭in‬ ‭taxes allows the government to close defcits through higher government revenues.‬ ‭Supply-side‬ ‭fscal‬ ‭policies‬ ‭used‬ ‭to‬ ‭increase‬ ‭the‬ ‭competitiveness‬ ‭of‬ ‭domestic‬ ‭producers‬ ‭in‬ ‭order‬ ‭to‬ ‭stimulate‬ ‭exports‬ ‭result‬ ‭in‬ ‭an‬ ‭appreciation‬ ‭of‬ ‭the‬ ‭domestic‬ ‭currency.‬ ‭This‬ ‭is‬ ‭due‬ ‭to‬ ‭the‬ ‭fact‬ ‭that‬ ‭an‬

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