Question

4. Suppose a country's output is below the policy makers' desired level of output and is experiencing a trade surplus. Assume that the policy makers' goals are to achieve the desired level of output (i.e., full employment output) and balanced trade. Given this information, what type of exchange rate and/or fiscal policy can be used to achieve simultaneously these two goals? Explain.

Answer 1

Expansionary fiscal policy and floating exchange rate will help in achieving desired output that is full employment.

In expansionary fiscal policy, government will increase its spending and reduce taxes. This will lead to rise in aggregate demand. Increase in aggregate demand will cause GDP ro rise and when economy of the country rises, there is a need of extra workers in order to fulfill the demands of the people. This, it provides employment to people and reduce unemployment rates.

Floating exchange rates are determined by the forces of demand and supply. This will help the country to overcome the problem of trade surplus and produce efficient quantity. In floating exchange rate, interest are set by external forces that does not cause any risk to FX reserves. With no risk to FX reserves, a country will be able to successfully implement full employment policies.