Given what you now know, do you think it was a good idea for the United States to adopt a policy mix of tight money and large government budget deficits in the early 1980s? Why or why not? What were the benefits and costs of reversing that policy mix in the 1990s?

Given what you now know, do you think it was a good idea for the United States to adopt a policy mix of tight money and large government budget deficits in the early 1980s? Why or why not? What were the benefits and costs of reversing that policy mix in the 1990s?

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December 6, 2021
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Given what you now know, do you think it was a good idea for the United States to adopt a policy mix of tight money and large government budget deficits in the early 1980s? Why or why not? What were the benefits and costs of reversing that policy mix in the 1990s?

Answer and ExplanationSolution by a verified expert

Explanation
The contractionary monetary policy reduced money supply while expansionary fiscal policy raised money demand in Country U due to which interest rates rose to lead to a flow of capital in U due to which its currency, that is, the dollar appreciated and created a rise in import and fall in exports of Country U. This led to a rise in trade deficit but inflation fell due to tight monetary policy in the 1980s.

The reverse of this policy mix in 1990 was expansionary monetary policy and contractionary fiscal policy. This policy mix reduced interest rates due to which capital flew out of Country U leading to a fall in interest rates and thereby depreciation of the dollar which created a rise in exports and a fall in imports.

Inflation on the other hand rose due to expansionary monetary policy. The benefits of the reverse policy mix in the 1990s were that trade deficit fell somehow initially and economic growth occurred due to a rise in exports. But the dollar kept on fluctuating in the 1990s and appreciated much during 1995-1998 leading to high costs in the form of the large trade deficit in the late 1990s and early 2000s.

Verified Answer
The tight monetary policy and expansionary fiscal policy in 1980 in Country U raised the interest rates due to which the dollar appreciated and thereby imports rose leading to a rise in the trade deficit.

However, inflation fell in the 1980s.

The reverse of this policy mix led to the fall in interest rates due to which the dollar depreciated and thereby exports rose. But fluctuations in the dollar kept on happening in the late 1990s due to which trade deficit continued to grow in the 1990s.

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