Question

2. Suppose that your government introduces an investment tax credit, which subsidizes domestic investment.

Answer 1

Answer:

National savings : there would be an increase in National savings due to the increase in real rate of interest

domestic investment: there would be increase in domestic investment  

Net capital outflow: there would be a reduction in net capital flow

interest rate : there would be an increase in investment loans which will cause an increase in interest rate

exchange rate; there would be an increase in the exchange rate due to the scarcity/ reduction in net capital outflow

trade balance: The rate of export will be reduced and this will lead to a trade deficit

Explanation:

Investment tax credit is an economic policy introduced by the government which enables Domestic Businesses to deduct a specified percentage of an investment cost from the Tax payable to the Government i.e tax been owed the government by the business and this helps in subsidizing domestic investment if this policy is passed into law it will greatly help in subsidizing domestic businesses. how does this policy affect:

National savings : there would be an increase in National savings due to the increase in real rate of interest

domestic investment: there would be increase in domestic investment  

Net capital outflow: there would be a reduction in net capital flow

interest rate : there would be an increase in investment loans which will cause an increase in interest rate

exchange rate; there would be an increase in the exchange rate due to the scarcity/ reduction in net capital outflow

trade balance: The rate of export will be reduced and this will lead to a trade deficit

Answer 2

Answer:

Explanation:

If the Congress passes an investment tax credit, this move will subsidizes domestic investment.

The drive to increase domestic investment causes firms to go for more loan, thus increasing the demand for loanable funds.

This causes the real interest rate to go up, consequently reducing the net capital outflow.

The downward slide in net capital outflow reduces the cash flow in the market for foreign exchange, invariably raising the real exchange rate.

The trade balance in the market also moves toward fiscal deficit, because net capital outflow, then the net exports, is lower.

The higher real interest rate also increases the quantity of national saving.

In short as saving increases, domestic investment increases, then net capital outflow declines, the real interest rate increases, the real exchange rate increases, and the trade balance moves toward a minus and deficit.