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1. “The U.S. trade deficit increased in February, as net exports fell victim to a strong...

1. “The U.S. trade deficit increased in February, as net exports fell victim to a strong U.S. dollar and continued economic weakness abroad. Foreign trade once again is proving to be a drag on overall U.S. economic growth, though domestic demand still appears strong.” The Wall Street Journal. What monetary policy action could be used to raise U.S. net exports? Explain how this change in interest rates would affect the value of the U.S. dollar, and in turn, both the level of exports and imports. Explain and graph using the Mundell-Fleming model of a large open economy.

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The monetary policy that could be used to raise the US net exports would be reduction of interest rates. As interest rates reduce, there is capital outflow from the country. This would lead to an decrease in demand for dollars which would lead to the dollar depreciating. As the dollar depreciates, imports become expensive and exports become cheaper. Hence net exports rise. Also, due to reduction of interest rates, production of goods increase leading to higher supply of exports. Higher supply puts a downward pressure on the export prices and hence demand for exports increase. Thus net exports increase.LM BP IS

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