Answer to Question #157297 in Macroeconomics for Ain

Question

Q2. If a local newspaper reported that the Malaysian government will shore up the sliding ringgit by working to cut record budget and trade deficits.

a) According to the model in this chapter, would a reduction in the budget deficit reduce the trade deficit? Would it raise the value of ringgit? Explain.

Answer 1

Reducing budget deficit results to a stronger exchange rate which makes it hard for Malaysian exporters to sell their rinngit abroad making imports more cheap leading to a reduced trade deficit. A budget deficit lead to a inflow of foreign financial capital, a stronger exchange rate and a trade deficit.

A reduction in budget deficit reduces the value of Malaysian rinngit because people will not buy the current due to increased exchange rate.