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:

Cerebrospinal Fluid

A clear, colorless body fluid found in the brain and spinal cord, which acts as a cushion protecting the central nervous system.

Subarachnoid Space

The subarachnoid space is a cavity filled with cerebrospinal fluid (CSF) located between the arachnoid membrane and the pia mater surrounding the brain and spinal cord, serving as a cushioning layer.

Spinal Cord

A long, thin, tubular bundle of nervous tissue and support cells that extends from the brain, conducting sensory and motor nerve impulses to and from the brain to the body.

Cervical

Relating to the cervix in the context of the female reproductive system or the neck region in the context of anatomy.