Which of the following policies would keep an economy operating at full potential while combating an excessive trade deficit and an overvalued domestic currency?
A) Reducing government spending and increasing the domestic money supply so that the interest rate falls at potential GDP
B) Increasing both government spending and the domestic money supply so that the interest rate increases at potential GDP
C) Reducing both government spending and taxes so that the interest rate falls and GDP climbs above potential
D) Increasing both government spending and taxes so that the interest rate increases even as GDP climbs above potential
E) Placing import restrictions on the country's largest imports

Question

Quizplus · Accepted Answer

Reducing government spending can help decrease the budget deficit, which can put downward pressure on the domestic currency, making exports more competitive. Increasing the domestic money supply lowers interest rates, which can further depreciate the currency, helping to correct the trade deficit without pushing GDP above its potential.

Which of the Following Policies Would Keep an Economy Operating