The twin deficit hypothesis claims that there is a link between fiscal deficit and trade deficit.The story goes as follo
Posted: Thu May 19, 2022 8:38 am
The twin deficit hypothesis claims that there
is a link between fiscal deficit and trade deficit.The story goes
as follows. If the government borrowing pushes up the interest
rate, the higher return will attract foreign funds. This pulls the
currencies held by foreigners away from purchasing exports towards
investing in financial assets, so the budget deficit is accompanied
by a trade deficit. Do you agree or disagree with this hypothesis?
How would your answer change if the economy were initially at a
liquidity trap? Explain your answer in the context of the
IS-LM model. (Hint: Consider a fiscal
expansion. Assume that consumption, investment, and net export are
all functions that decrease with an increase in the interest
rate.)
is a link between fiscal deficit and trade deficit.The story goes
as follows. If the government borrowing pushes up the interest
rate, the higher return will attract foreign funds. This pulls the
currencies held by foreigners away from purchasing exports towards
investing in financial assets, so the budget deficit is accompanied
by a trade deficit. Do you agree or disagree with this hypothesis?
How would your answer change if the economy were initially at a
liquidity trap? Explain your answer in the context of the
IS-LM model. (Hint: Consider a fiscal
expansion. Assume that consumption, investment, and net export are
all functions that decrease with an increase in the interest
rate.)