Question

Use the model of the small open economy to predict what would happen to the trade balance, the real exchange rate, and the nominal exchange rate in response to a fall in the confidence of consumers about the future that induces them to spend less and save more. 1. The trade balance would increase . 2. The real exchange rate would fall . 3. The nominal exchange rate would fall .

Answer 1

In response to a fall in the confidence of consumers about the future that induces those to spend less and save more will lead to:

Trade balance gets improvement.

The actual exchange rate rises

The nominal exchange rate falls

Step-by-step explanation:

A rise in savings moves the schedule of savings to investment (S – I) to the right, increasing the number of dollars available for investment abroad. The increased dollar supply allows the actual exchange rate to drop in equilibrium.

As the dollar is becoming less competitive, domestic goods are becoming less costly compared to foreign products, so exports are increasing and imports are decreasing. This implies an improvement in the trade balance.

The nominal exchange rate falls as the actual exchange rate rises, as rates do not adjust in reaction to this shock.