Currency Depreciation Improves Trade Balance at Full Employment

Steps:

• Persistent current account deficit requires boosting exports or curbing imports to improve balance of payments.
• Low unemployment means economy is near full capacity, so expansionary policies risk inflation without much employment gain.
• Managed floating exchange rate allows government intervention to depreciate currency, enhancing competitiveness.
• Evaluate policies: seek one that expands net exports without contracting demand, preserving low unemployment but raising prices.

Why A is correct:

• Depreciation lowers export prices and raises import prices, increasing net exports per the Marshall-Lerner condition, boosting aggregate demand and causing inflation at full employment without raising unemployment.

Why the others are wrong:

• B: Higher direct taxation reduces disposable income and aggregate demand, likely increasing unemployment.
• C: Higher import tariffs protect domestic firms but raise consumer prices without directly expanding output, potentially causing inefficiencies without addressing unemployment.
• D: Higher interest rates attract capital inflows, appreciating the currency and worsening the deficit while contracting demand, risking higher unemployment.

Final answer: A