Posted by Anonymous on .
In a small open economy, if the government adopts a policy that lowers imports, then that policy raises the real exchange rate and does not change net exports.
I don't get the above statement. From my understanding, lower imports means higher net exports from NX = Exports - Imports. They are inversely related. Since NX is higher, that means e is lower and E must be lower as well (they are positively related). Please explain why the statement above is true and mine is not.
Macroeconomics - NX & Tax -
In the long run, in an open economy, imports=exports.
If a country limits imports but continues to export, then goods are flowing out and foreign currency flows in. What good is that foreign currency if the holders cant buy anything with it? (Think about it, if imports are completely restricted, then the foreign currency would be worthless). Anyway, since it is harder to import, foreign currency is worth less. So, either the exchange rate drops or exports drops. With a drop in the exchange rate, imports become more expensive, and exports drops because, foreigners, the cost of the goods from our small country went up. Equilibrium is achieved when, at the new exchange rate, imports=exports.
I hope this helps.