Compare and contrast the effects of a domestic-led expansion (due to a change in G or T) versus an export-led one (due to a change in Y* or a currency devaluation) in a short-run open economy Keynesian model. Show the impacts on NX and Y (qualitative only). How are the qualitative effects similar or different? Why do the differences matter for policy purposes?

 

A domestic-led expansion (due to a change in G or T) increase income level that increase AD and increasing AD increase price level and output in the short-ter. But when the government increase spending, its occur budget deficit. When budget deficit occur, the government borrow money from the open market that increase demand for loanable fund that increase interest rate. Increasing interest rate decrease or eliminate private investment (also called crowding-out effect) that negatively affect the economic growth. Other side increasing taxes decrease disposable income that decrease spending capacity of tax payers and its decrease consumption. Decreasing consumption decrease AD that decrease output and price level that is unfavorable for the economy. When government borrowing increase, its increase GDP-Debt ratio and increase the loan paying liability of the government in the future and the government increase taxes to increase revenue to repay its loan. So in long-term its negatively affect the economy and its change the consumer perception and behavior in the short-term due to fear of high taxation in the future. When government purchases increase its increase import that decrease net export. A government purchases contribute a large part in trade and its widely affect the trade volume and structure. So, increasing government purchases increase imports and decrease net exports.

Other side, a domestic-led expansion that is an export-led one (due to a change in Y* or a currency devaluation) increase AD and increasing AD increase output and price level. When export increase, its increase demand for the domestic currency and strengthen the domestic currency.

During the a domestic-led expansion (due to a change in G or T) the central bank need of an expansionary monetary policy to decrease interest rate to increase private investment spending. Due to increasing government borrowing interest rate increase that negatively affect to the private investment spending. Other side, a domestic-led expansion that is an export-led one (due to a change in Y* or a currency devaluation) increase AD and increasing AD increase output and price level. So, here the central bank adopts a contractionary monetary policy that decrease money supply and control inflation that increase due to increasing price level.