Assume that a country is operating at full employment.According to the absorption approach, the only way that currency depreciation can improve the balance of trade is for the country to implement
A) expansionary fiscal policy to increase domestic spending.
B) expansionary monetary policy to increase domestic spending.
C) contractionary fiscal policy or monetary policy to cut domestic spending.
D) import tariffs and quotas that increase spending on domestically produced goods.

Question

Quizplus · Accepted Answer

According to the absorption approach, if a country is already operating at full employment, currency depreciation may lead to higher imports and inflation, and therefore, the only way to improve the balance of trade is to implement contractionary fiscal or monetary policy to reduce domestic spending. This can be achieved through measures such as reducing government spending, increasing taxes, or raising interest rates. Implementing expansionary fiscal or monetary policy would only lead to higher domestic spending, and therefore, would not improve the balance of trade. Import tariffs and quotas can protect domestic industries, but may not necessarily improve the balance of trade as they can also lead to retaliation from trading partners and higher prices for consumers.

Assume That a Country Is Operating at Full Employment