Use the second model in this chapter to answer these questions. The govemment in an SUE is concerned that the current account decit is too high. One group of economic advisers to the government argues that high government deficits cause the current account deficit to be high and that the way to reduce the current account decit is to increase taxes. A second group of economic advisers argues that the high current account deficit is caused by high domestic investment and proposes taxing domestic investment and returning these tax revenues to consumers as lump-sum transfers. a. Which advice should the government take if its goal is to reduce the current account decit? Explain. The government shouldn't take advice from either group of economic advisers. Both suggested policies would have no effect on the current account of the nation. The increase in lump-sum taxes has no effect on the nation's present-value budget constraint and therefore no effect on the current account. The investment tax will reduce domestic investment, but also reduce domestic output. Therefore, the net effect would leave the current account unchanged. The best advice to take would be adopting the investment tax. Atax on investment would have no effect on the nation's present-value budget constraint and the level of consumption and government spending would be unaffected. Therefore, there is no effect on the current account. An increase in lump-sum taxes would decrease the level of consumption in the nation and increase the current account of the nation. The government could take advice from either group of economic advisers. Both suggested policies would be effective in increasing the current account of the nation. The increase in lump-sum taxes results in a decrease in the level of consumption in the nation and increases the current account. The investment tax decreases domestic investment and increases net exports which also increases the current account. "' The best advice to take would be adopting the investment tax. If the government were to increase lump-sum taxes there would be no effect on the current account. By introducing a tax on investment, the level of domestic investment decreases and the level of net exports increases. This results in an increase in the current account of the nation. b. Is the government's goal of reducing the current account deficit sensible? Why or why not? What will happen if the government takes the advice that achieves its goal, as in part (a)? The government's goal of reducing the current account deficit is implemented, V and it would because V Y for the economy to grow its way out of the situation that caused the decit. If the policy D. The best advice to take would be adopting the investm were to increase lump-sum taxes there would be no effect on the current account. By introducing a tax on investment, the level creases and the level of net exports increases. This results in an increase in the current account of the nation. is sensible b. Is the government's goal of reducing the current account de is not sensible not? What will happen if the government takes the advice that achieves its goal, as in part (a)? The government's goal of reducing the current account deficit because If the policy s implemented, and it would for the economy to grow its way out of the situation that caused the deficit.C. The government could take advice from either group of economic advisers. Both the nation. The increase in lump-sum taxes results in a decrease in the level of co the deficit is slowing the growth of the nation. it tax decreases domestic investment and increases net exports which also increas D. The best advice to take would be adopting the investment tax. If the government the deficit is preventing efficient growth in aggregate output. account. By introducing a tax on investment, the level of domestic investment dec n the current account of the nation. the deficit is allowing consumers higher levels of consumption. Is the government's goal of reducing the current account deficit sensible? Why or why the deficit is being used to finance investment spending. al, as in part (a)? e government's goal of reducing the current account deficit because If the policy implemented, and it would for the economy to grow its way out of the situation that caused the deficit.The gove up UI UCUnOmg advisers. DOIT suggestou pullties would De UneGive In Increasing The current account UI the nation s in a decrease in the level of consumption in the nation and increases the current account. The investment tax decre welfare would be higher ; net exports which also increases the current account. D. The best estment tax. If the government were to increase lump-sum taxes there would be no effect on the current account. welfare would be lower evel of domestic investment decreases and the level of net exports increases. This results in an increase in the currel b. Is the governn consumption would be lower nt deficit sensible? Why or why not? What will happen if the government takes the advice that achieves its goal, as in part ( output would be higher The government' eficit because If the policy is implemented, and it would for the economy to grow its way out of the situation that caused the deficit.he government's goal of reducing the current account d be more difficult not? What will happen if the government takes the advice that achieves its as in part (a)? be easier overnment's goal of reducing the current account deficit If the policy lemented, and it would for the economy to grow its way out of the situation that caused the deficit