Please help me out?

Question

Why do think the European Union countries decide to have a single central bank and a single currency, instead of just agreeing to maintain fixed exchange rates among their currencies?

6a)What fiscal policies are recommended by conservative “supply-side” economists?

6b) What assumptions about the behavior of savers and investors are required for conservative supply side theories of the benefits of tax cuts to be correct?

6c) Why did the experience of the 1980's following the massive Reagan tax cuts discredit supply side theory in the eyes of many economists?

7) How can large government deficits lead to large trade deficits?

8) Although the monetary authorities are concerned that the high level of the $ exchange rate is contributing to the large US balance of trade deficit, they are afraid of a sudden major negative shift in investor sentiment towards the $.

Answer 1

6a)What fiscal policies are recommended by conservative “supply-side” economists?

Ans:

Reduce tax rates, keep interest rates low.

6b) What assumptions about the behavior of savers and investors are required for conservative supply side theories of the benefits of tax cuts to be correct?

Ans: Assumptions required are that the savers will increase their savings rather than using the additional income due tro tax cut mostly for increased consumption, that the companies will use their higher post tax internal cash accruals for capacity expansion investments and the investors will find the post tax returns more attractive to take risks and make investments in capacity to augment supplies. Also, the RGDP would grow resulting in higher tax revenues to help reduce Govt. deficit.

6c) Why did the experience of the 1980's following the massive Reagan tax cuts discredit supply side theory in the eyes of many economists?

Ans: This is because the assumptions did not hold good, especially the tax bouyancy expected did not occur and higher govt. borrowings had a crowding out effect on private sector investment. More important, the economic diagnosis was not correct - wrong medicine applied at the wrong time.

7) How can large government deficits lead to large trade deficits?

Ans: Large govt. budget deficits leads to expansion in aggregate demand through the multiplier process and this results in higher prices if the economy is in oer near ull employment or suffering from capacity bottlenecks. Higher prices makes imported goods attractive and consumers buy imported goods resulting in higher trade deficit, especially if the external value of the country's currency remains strong.

8) Although the monetary authorities are concerned that the high level of the $ exchange rate is contributing to the large US balance of trade deficit, they are afraid of a sudden major negative shift in investor sentiment towards the $.

Ans:  This is true. The dollar continues to be overvalued given its already large trade deficit.  While the dollar has been depreciating over time, this has been at a slow rate iof depreciation. A large depreciation within a short period would have helped curb imports and encourage exports so that the trade balance improves significantly, but such a sudden depreciation of a large percentage would have shocked international investors who would havew found  the value of their dollar denominated investments in the US go down sharply and that could have resulted in panic withdrwal of investments from the US. The  capital inflows to the US would have dipped suddenly. This could affect the investments in US resulting in lower ca[pacity growth, job losses and accentuate the economic slowdown and recession. US needs softlanding.