Suppose that the U.S. government and Congress approve a policy to target a decrease in the government deficit.
(a) Using the closed economy model, which policy would achieve this goal (choose one for your analysis)? Hint: A decrease in G or an increase in T
Now assume the U.S. as a large open economy. Use the LOE model to state and explain what the long run effects of this policy will be on:
(b) The U.S. interest rates, investment, net foreign investment, real exchange rates (ε) and trade balances (NX).
(c) Show graphically the effects of this policy on the U.S. market for loanable funds and on its foreign currency market. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the new long-run equilibrium values.