| The world is made; up of only two large countries: Eastland and Westland. Westland is running a large current account deficit and often appeals to Eastland for in reducing this current account deficit. Currently, the government of Eastland purchases $10 billion of goods and services, and all these goods and services are produced in Eastland. The finance minister of Eastland proposes that the government purchase half of its goods from Westland. Specifically, the government of Eastland will continue to purchase $10 billion of goods, but $5 billion will be from Eastland and $5 billion will be from Westland. The finance minister gives the following rationale: “Both countries produce identical goods, so it does not really matter to us which country produced the goods we purchase. Moreover, this change in purchasing policy will reduce Westland’s large current account deficit.” What are the effects of this change in purchasing policy on the current account balance in each country and on the world real interest rate? (What happens to net exports by the private sector in each country after the government of Eastland changes its purchasing policy?) |
