Suppose that a nation is at full employment without inflation but has a deficit in its balance of payments. (a) Explain why a depreciation of the nation’s currency will not correct the deficit unless real output rises or domestic expenditures (absorption) fall. (14) (b) How can the nation’s output rise as a result of the depreciation? (12) (c) How can domestic absorption fall automatically as a result of the depreciation? (14) (d) How can the government help reduce domestic absorption and make the devaluation effective? (10)
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