Question

1. In 2019, the United States is experiencing an unemployment rate that is below its natural rate of unemployment. That is, its labor force is more than fully employed. However, the country is suffering from a rising fiscal deficit, a rising government debt/GDP ratio, and an expanding current account deficit. In addition, after years of quantitative easing in the wake of the 2008-09 financial crisis and economic recession, the Federal Reserve must now roll back its quantitative easing and shrink its balance sheet. Suppose macroeconomic policymakers want to achieve all the following goals:

1. Lower employment to full-employment level to prevent overheating of the economy
2. Reduce the fiscal deficit and rein in the growth in government debt
3. Shrink the Central Bank’s balance sheet
4. Reduce current account deficit
5. Maintain a stable US dollar to prevent imported inflation

Would there be any monetary, fiscal, and trade policy combination that would allow the policymakers to achieve all these above-mentioned objectives simultaneously in the short-run? If your policy proposals are adopted, explain what will happen to America’s real GDP, real interest rate, and net capital outflow.

Answer 1

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