In 1990, Japan’s Ministry of International Trade and Investment (MITI) proposed that firms be given a tax credit equal to 5% of the value of its increased imports. The purpose of this tax subsidy is to encourage Japanese imports of foreign products and thereby reduce Japan’s persistent trade surplus. At the same time, the Japanese government announced that it will reduce its budget deficit during the coming year.

a. What are the likely consequences of the tax subsidy plan on Japan’s trade balance, the value of the yen, and the competitiveness of Japanese firms?

b. What are the likely consequences of a lower Japanese budget deficit on Japan’s trade balance?