A in April 1995, Michel Camdessus, Managing Director of the International

question 30

Essay

a In April 1995, Michel Camdessus, managing director of the International Monetary Fund (IMF), aificized U.S. economic policy for allowing the dollar exchange rate to fall too low.
He recommended that the United States reduce its budget deficit in order to raise the exchange rate. Use the long-run model of a small open economy to illustrate graphically the impact of reducing the government's budget deficit on the exchange rate and the trade balance. Be sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction the curves shift
v. the new long-run equilibrium values

b. Based on your graphical analysis, explain whether Mr. Camdessus's policy recommendation will work. Specifically state what happens to the exchange rate and the trade balance as a result of the government budget deficit reduction.

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Definitions:

Draw Blood

The process of puncturing a vein to obtain a sample of blood for analysis or donation.

Radial Vein

A vein located in the forearm that runs alongside the radius bone, draining blood from the hand back toward the heart.

Hemiazygos Vein

A vein on the left side of the vertebral column that drains blood from the posterior walls of the thorax and abdomen into the superior vena cava.

Brachiocephalic Vein

A large vein formed by the union of the internal jugular and subclavian veins, draining blood from the head, neck, upper limbs, and upper chest.