New+Ch[1].19+Answer -...

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Ch.19 Suggested Answer (Problems and Applications) 1. Japan generally runs a trade surplus because the Japanese savings rate is high relative  to Japanese domestic investment. The result is high net capital outflow, which is matched  by high net exports, resulting in a trade surplus. The other possibilities (high foreign  demand for Japanese goods, low Japanese demand for foreign goods, and structural  barriers against imports into Japan) would affect the real exchange rate, but not the trade  surplus. 2. a. A reduction in the U.S. government budget deficit would increase national saving,  shifting the supply curve of loanable funds to the right in  Figure 3. This would  reduce the real interest rate in the United States, thus increasing net capital  outflow, and reducing the real exchange rate. The real value of the dollar would  decline, not increase as the president suggested. However, the trade deficit will  decline. 1
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Chapter 32/A Macroeconomic Theory of the Open Economy   2 Figure 3 b. The increased confidence would lead to a reduction in net capital outflow as  shown in  Figure 4. The demand for loanable funds will fall, along with the real  interest rate. The decline in net capital outflow will also reduce the supply of  dollars, increasing the real exchange rate. Thus, the trade balance will move  toward deficit. Figure 4
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Chapter 32/A Macroeconomic Theory of the Open Economy   3 3. If Congress passes an investment tax credit, it subsidizes domestic investment. The  desire to increase domestic investment leads firms to borrow more, increasing the  demand for loanable funds, as shown in  Figure 5. This raises the real interest rate, thus  reducing net capital outflow. The decline in net capital outflow reduces the supply of  dollars in the market for foreign exchange, raising the real exchange rate. The trade  balance also moves toward deficit, because net capital outflow, hence net exports, is  lower. The higher real interest rate also increases the quantity of national saving. In  summary, saving increases, domestic investment increases, net capital outflow declines, 
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This note was uploaded on 11/02/2009 for the course FB cc2105 taught by Professor Alan during the Spring '07 term at École Normale Supérieure.

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New+Ch[1].19+Answer -...

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