Question

Fixed exchange rates and foreign macroeconomic policy Consider a fixed exchange rate system, in which a group of countries (called follower countries) peg their currencies to the currency of one country (called the leader country). Because the currency of the leader country is not fixed against the currencies of countries outside the fixed exchange rate system, the leader country can conduct monetary policy as it wishes. For this problem, consider the domestic country to be a follower country and the foreign country to be the leader country.

A) Fiscal policy involves changing government spending or changing taxes. Design a fiscal policy mix that leaves consumption and domestic output unchanged when the leader country increases interest rates What component of output is changed?

PLEASE SOLVE AND EXPLAIN IN DETAIL.

Thanks!

Answer 1

So, as with an increase in the interest rate of the leader country leads to the inflow of the capital and investments to them from the other foreign countries. Due to which there is an appreciation of the currency value of the leader country than the follower country.

(A) so to maintain the consumption and the domestic outputs so that it remains unchanged when leading country increases the intrest rate. Then the mix fiscal policy to be formed will be increasing the government spending over the domestic goods and services and the industrial sector and increasing the import tariffs over the goods and services from the foreign countries and decreasing the export tariffs over the domestic goods and services so that the customer in the follower country will consume the goods and services provided by the follower country because due to an increase in the import tariffs lead to the rise in the price of the foreign goods, by this there will be consumption of the follower country's goods have comparative advantage over the leader country then there will be more consumption and and by government spending there will be generation of employment in the economy and increase in the level of outputs.

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