Suppose there are only two countries in the world, Foreign and Home. Foreign is a large country while Home is small country. Currently, Home runs a huge trade deficit. Concerning about the country's trade balance, the government of Home begins to look for policy that can correct its trade deficit. The Home government asks you for recommendation. In addition, the Home government wants you to use the long-run classical model of a small open economy to evaluate the long-run effects of your recommended policy on the Home's key macroeconomics variables (output, national saving, investment, real interest rate, net foreign investment, net exports, real exchange rate, nominal exchange rate, price level, and unemployment rate).
What policy would you recommend? What happens to the key macroeconomic variables in the long run? Explain.

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In the context of a small open economy where Home is a small country with a trade deficit there are several policy options that the government of Home can consider to correct its trade imbalance One p... View the full answer