Note: i) Y is real domestic output; ii) E is exchange rate in domestic currency/foreign currency terms, iii) if a government maintains a balanced budget, this implies that total government expenditure is financed from government taxes . > implies there is a government budget deficit.

Now assume that there is no law that requires the government to maintain a balanced budget at all times. Assume further that the government cuts taxes temporarily which leads to a budget deficit.

Question: Compare the effect on Y and E in the short-run if there is only a temporary decrease in taxes without the expectation that the government will monetise the debt in the future? (Please provide a written solution not a graph)