Question

Suppose that Congress is considering an investment tax credit, which subsidizes domestic investment.
a. How does this policy affect national saving, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance?

Answer 1

In this exercise, we must determine the effects of the policy on national saving.

The demand for loanable funds will rise as a result of this investment tax credit's promotion of domestic investment. This increased demand for loanable money will result in higher interest rates. Greater national saving will result from higher interest rates.

With these increased interest rates, net capital outflow will decline, reducing the amount of dollars available on the FX (foreign currency) market. The dollar supply will be less, which will result in a higher exchange rate. As imports become more affordable for Great Britain relative to exports, the trade balance will finally start to move toward a deficit.

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