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Chapter 29: Problem 4

An article in the Economist quoted the finance minister of Peru as saying, "We are one of the most open economies of Latin America." What does he mean by saying that Peru is an "open economy"? Is fiscal policy in Peru likely to be more or less effective than it would be in a less open economy? Briefly explain.

Short Answer

Expert verified
An 'open economy' refers to an economy that engages in international trade of goods, services, capital and allows for mobility of labor and investments. Peru being described as such suggests it heavily engages in these activities. Fiscal policy would be less effective in an open economy like Peru compared to a less open economy due to increase in imports, potential rise in interest rates which can lead to exchange rate appreciation, thus reducing net exports.

Step by step solution

01

Understand Key Terms

An open economy is one that allows its citizens and businesses to trade goods, services, and capital with those outside the country. Fiscal Policy is the use of government revenue collection and expenditure to impact the economy.
02

Interpret the Finance Minister's Statement

When the finance minister of Peru refers to Peru as an 'open economy', it means that its economy is integrated with the world economy, allowing for free trade, foreign investments, and international tourism.
03

Compare Fiscal Policy effectiveness in Open vs Closed Economies

Fiscal policy in an open economy like Peru is likely to be less effective than in a closed one. That's because in an open economy, government spending could lead to an increase in imports rather than an increase in domestically produced goods and services; moreover, a fiscal expansion may lead to a rise in interest rates which could attract foreign capital, leading to an appreciation of the exchange rate and a reduction in net exports.

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Most popular questions from this chapter

Why does monetary policy have a greater effect on aggregate demand in an open economy than in a closed economy?

Briefly explain whether you agree with the following statement: "Because in 2016 national saving was a larger percentage of GDP in the United States than in the United Kingdom, domestic investment must also have been a larger percentage of GDP in the United States than in the United Kingdom."

Writing in the New York Times, Simon Johnson, an economist at MIT, made the argument that people outside the United States may at some point decide to "save less (in which case they may hold onto their existing United States government debt but not want to buy so much of new issues)." What does saving by people outside the United States have to do with sales of U.S. government debt? Does the level of domestic investment occurring in foreign countries matter for your answer? Briefly explain.

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Former member of Congress and presidential candidate Richard Gephardt once proposed that tariffs be imposed on imports from countries with which the United States has a trade deficit. If this proposal were enacted and if it were to succeed in reducing the U.S. current account deficit to zero, what would be the likely effect on domestic investment spending within the United States? Assume that no other federal government economic policy is changed. (Hint: Use the saving and investment equation to answer this question.)
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