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The American Society of Civil Engineers (ASCE) has recently published its new Infrastructure Report Card,

https://www.infrastructurereportcard.org/, arguing that the infrastructure of the US economy is in poor shape and requires an annual investment of more than $200 billion over 10 years to upgrade it to acceptable levels. The US policymakers (both current office holders and potential contenders for office in the coming years) have bought into this argument and are considering following ASCE's recommendation. See, for example, the news report, https://thehill.com/homenews/campaign/447515-sweeping-plans-from-2020-contenders-come-with-trillion-dollar-price-tags. Assume that the Federal Government plans to launch such a policy in 2020 and end it in 2029, investing $200 billion per year in a series of infrastructure projects. Also, assume that the goods and services used for investment in these projects are mostly nontradables, and it takes three years for each investment project to mature (i.e., reach a stage where it yields improved and expanded infrastructure services). Note that infrastructure services themselves are nontradable and investing in them ultimately raises the supply of non-tradables in the economy.

In the following questions, please compare the outcomes under the infrastructure plan of the Federal Government with a base case where no such plan is implemented. Assume that if the infrastructure plan is implemented, the trends in other government expenditures, in money supply, and in all other policies and parameters in the US and abroad remain the same as in the base case, unless explicitly mentioned. Finally, assume that the aggregate price level in the US and elsewhere will be the same in all years whether the infrastructure plan is implemented or not.

a. What is likely to happen to the real exchange rate of the US economy in the long run (after ten years) if the government proceeds with the infrastructure plan, as compared to the base case? How about the nominal exchange rate? Please explain how and why the nominal and real exchange rates under the plan may differ from the one under the base case.

b. Suppose the government proceeds with the infrastructure investment plan and decides to finance it by selling bonds. What is likely to happen to the nominal interest rate in the US economy in the short run (next year) under the government's infrastructure plan as compared to the base case?

c. In the situation in part (b), can one clearly conclude whether the nominal exchange rate of the US dollar would appreciate or depreciate in the short run (next year) vis-à-vis foreign under the government's infrastructure plan as compared to the base case? How about the real exchange rate? Keep in mind that the long-run exchange rate that you found in (a) should serve as the expected exchange rate in the analysis of the short-run situation in this part. Please explain how and why the nominal and real exchange rates under the plan may rise or decline or remain the same compared to the situation under the base case.

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