Fiscal Policy at Home POLICIES If the government expands domestic spending by increasing government purchases then G will reduce national savings With an unchanged world real interest rate investment will remain unchanged Savings will fall below investment A trade deficit is run If the government decreases taxes T decreases disposable income increases consumption increases and national savings decreases These both shift the vertical line that represents savings to the left Starting from a balanced trade a change in fiscal policy that reduces national savings leads to a trade deficit REAL EXCHANGE RATE If the government reduces national savings by increasing government purchases or cutting taxes a trade deficit will occur The real exchange rate will increase and net exports will be reduced Fiscal Policy Abroad POLICIES If a foreign government increases their government purchases then world savings is decreases This causes the world interest rate to rise This will reduce investment Savings will now exceed investment This will lead to a trade surplus at home ONLY HE WORLD INTEREST RATE WILL INCREASE REAL EXCHANGE RATE If foreign governments increase government purchases or cuts taxes the result will be a reduction in world savings and a rise in the world interest rate This causes a trade surplus Shifts in Investment Demand POLICIES If investment shifts outward the demand for investment goods at every interest rate increases investment will be greater than savings Net capital outflow will now be negative This causes a trade deficit REAL EXCHANGE RATE If invest demand increases then this increase will lead to higher investment This means the S I curve will shift to the left causing a trade deficit Wage Rigidity 1 Minimum Wage laws 2 Monopoly power of unions 3 Efficiency wage
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