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Chapter 21: Macro Policy in a Global Setting
Chapter 21: Macro Policy in a Global Setting
Questions and Exercises
1.
A sudden drop in the value of the dollar would result in inflationary pressures for
the United States. To counteract that decline, the United States would have to run
contractionary monetary and fiscal policies, both of which would help boost the
dollar. Unfortunately, they would also slow U.S. economic activity.
2. a. I’d rather be holding other currencies because their price is expected to rise. I
could buy them low and sell them high for a profit.
b. The same argument doesn’t hold for the Chinese government because it has
greater concerns than personal profit, such as the effect of a falling dollar on its
economy.
c. It might want to buy dollars to keep up the dollar’s value. In fact, since the
government can print yuan, it could theoretically buy as many dollars as it desires.
It would want to buy dollars if it feels that the declining dollar would harm its
exports. A declining dollar makes Chinese exports more expensive for Americans
to buy and falling exports would slow the Chinese economy.
3.
If Japan and China ran an expansionary monetary policy, it would increase
Japanese and Chinese imports of U.S. goods and thereby decrease the U.S. trade
deficit.
4.
A contractionary fiscal policy by Japan and China would decrease Japanese and
Chinese imports of U.S. goods and would make the U.S. trade deficit worse.
5.
Increased money → increased income → increased imports → increased trade
deficit.
6. a. Expansionary monetary or fiscal policy.
b. If interest rates have risen steadily along with a rise in the exchange rate, it is
likely fiscal policy. Expansionary monetary policy reduces interest rates.
c. Yes, that would increase capital flows into the country, which, in order for the
balance of payments to be equal, would require a trade deficit.
7. a. I would suggest that the IMF require a contractionary policy for both monetary
and fiscal policy. I would, however, suggest a relatively more contractionary
fiscal policy so that the exchange rate would also fall while inflation falls,
boosting exports.
b. This would tend to slow inflation, after an initial burst due to a fall in the
exchange rate. The policy, however, would hinder growth and push the economy
into a (hopefully short-lived) recession.
c. I suspect that the country’s government would not be happy about the proposal
because its adoption might lead to a deep recession, which is politically
unpopular.
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Chapter 21: Macro Policy in a Global Setting
8.
a.
b.
c.
d.
9.
The first advice I would give would be to explain that at most, I can talk about
tendencies rather than achieving goals. Not all goals are simultaneously
achievable. That advice given, I would provide the following recommendations:
We would suggest a contractionary fiscal policy, which lowers inflation and the
interest rate directly and reduces the trade deficit by lowering income. It will also
increase the capital inflow, which will tend to allow an increase in the trade
deficit.
These goals are difficult to achieve simultaneously. While one could use a
combination of monetary and fiscal policies—expansionary monetary policy
would lower the trade surplus and lower interest rates, but would cause upward
pressure on prices. To offset this, contractionary fiscal policy could be used, but
that would also result in increasing the trade surplus and raising interest rates.
An expansionary monetary policy will reduce interest rates and reduce
unemployment too, but it will increase the trade deficit. Expansionary fiscal
policy will increase interest rates.
This combination of goals is difficult to achieve. Expansionary fiscal policy will
tend to reduce unemployment and increase interest rates. But to offset the effect
of higher income on increasing the trade deficit, an expansionary monetary policy
will have to be implemented to depress the dollar and spur exports to lower the
trade deficit. This works in the opposite direction from expansionary fiscal policy
by reducing employment and the interest rate. Life is tough.
The answer to this question hinges on what is meant by "justified." If that means
that the United States is complaining about the actual negative consequences it
experiences because of this policy, such as a higher trade deficit and possibly an
artificially high value for the dollar, one can say the complaint is justified. If the
argument centers on fairness, the issue is clearly complicated by the question of
whether a nation should put its goals ahead of, or secondary to, international
goals. The United States benefits from China’s export-driven policies in the form
of cheaper imported goods.
10. a. If the recession was caused by a fall in domestic expenditures, we would expect
that its trade balance was moving toward a surplus. If, however, the recession was
caused by a fall in exports, we would expect that its trade balance was moving
toward a deficit.
b. The G-8 countries were trying to get Japan to boost its economy by increasing
aggregate expenditures with expansionary monetary or fiscal policy.
11. a. One would expect less stabilization, because when one country’s income falls,
foreign incomes will likely fall too. This will lead to falling exports for the first
country, which will further decrease income.
b. This would increase the possibility of a global recession whenever one country
goes into a recession.
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Chapter 21: Macro Policy in a Global Setting
c. Answers on this can differ; an expected answer is that one will need coordinated
counter cyclical policy organized through G-8, World Bank, or some other
international organization.
12.
To finance the debt the U.S. government has to sell more bonds. Because
foreigners also demand these bonds (demand is greater), the government doesn’t
have to pay as high interest rates as it would if only U.S. investors demanded
government bonds. Thus, the interest rate doesn’t rise as much and crowding out
is reduced.
13.
The costs of internationalizing the debt are that interest and profits must be paid
on the capital owned by foreigners. Future consumption must be reduced to pay
that amount. Also, foreign governments and individuals can potentially gain
economic leverage over U.S. national institutions.
14.
If the financial and capital account were balanced and remained balanced, the
exchange rate for a country that gained a comparative advantage in most goods
would rise because the demand for its currency would rise. Demand for currency
would rise because foreigners would want to buy more goods from this country
because it could produce goods at a lower cost than other countries and therefore
could offer those goods for lower prices. Another way to look at it is that exports
would exceed imports, creating a trade surplus, which would not be offset by a
financial and capital account deficit, so that there would be an excess demand for
the currency. This excess demand would lead to a higher exchange rate.
Issues to Ponder
1.
This question requires student research. At the time that this was written, the
dollar had fallen against the yen. This makes U.S. exports cheaper to the
Japanese, but may signal weaker investor confidence in the U.S. economy. This
may mean foreign investors are pulling out of U.S. assets, which will also lead to
lower stock prices and perhaps higher interest rates. A lower dollar also means
imports are more expensive, which puts upward pressure on domestic inflation
and makes traveling in foreign countries more expensive. Whether the dollar
should be higher or lower depends on who you are. Manufacturers whose sales
depend on exports want a lower exchange rate. Investors likely want a higher
exchange rate.
2.
This question requires student research. At the time that this was written, the U.S.
trade deficit had risen to record highs. Still, it is unclear whether we should want
to lower the U.S. trade deficit. The trade deficit was in part due to the fact that the
economy had been growing for a number of years. (During the 2008/09 recession
the trade deficit fell somewhat). As long as the United States can borrow or sell
assets, it can have a trade deficit. On the other hand, the more the United States
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Chapter 21: Macro Policy in a Global Setting
borrows, the more U.S. assets foreigners own. Eventually, the United States will
have to run a trade surplus.
Colander’s Economics, 8e. McGraw Hill © 2010
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