The direction of change in the trade balance is uncertain because expansionary monetary policy may exert forces in the opposite direction. What are they?
A) An increase in income tends to lower the trade balance, whereas a fall in interest rates through depreciation tends to raise the trade balance.
B) An increase in the supply of money raises interest rates, which lowers the trade balance, whereas the increase in the demand for money raises it.
C) Exchange rates rise (depreciation) and expected exchange rates fall (appreciation).
D) An increase in financial assets raises foreign inflows and raises the trade balance, whereas decreases in interest rates lower the trade balance.

Question

Quizplus · Accepted Answer

An expansionary monetary policy typically leads to lower interest rates, which can depreciate the domestic currency, making exports cheaper and imports more expensive, potentially improving the trade balance. However, the same policy can also increase domestic income, leading to higher import demand and potentially worsening the trade balance. Thus, these opposing forces create uncertainty in the direction of change in the trade balance.

The Direction of Change in the Trade Balance Is Uncertain