Answer to Question #287002 in Macroeconomics for onesime

Question

 

1. Looking at the IS-LM model, please explain what would happen if your local currency depreciates against the currency of your major trading partner. Would the situation be the same when your economy is in a liquidity trap? Why? Why not?

Answer 1

When there's a depreciation in local currency, imports from the major foreign trader become expensive. The IS curve therefore shifts its position to the left signalling a decrease in Investment Savings. On the other hand, the Liquidity Preference Supply of Money declines when local currency depreciates. Yes. The situation would be similar when there is a scenario of liquidity trap. This is predicated on the decreased flow of cash in the economy because majority of the players in the economy spend alot for imports compared to exports. The outcome is a negative balance of trade.