Answer
a) If Congress passes the tax credit, then the government is essentially providing a subsidy for investing in the country. Domestic investment increases.
Since domestic investment increases, then there is an increased demand for loanable funds. The increased demand for loanable funds increases the interest rate. Increasing the interest rate then decreases net capital outflow. Decreasing the net capital outflow then decreases how much money is available on the foreign exchange market, increasing the exchange rate.
Since the net capital outflow is lower, the trade balance shifts more toward a deficit. The higher interest rate also increases the amount of national saving.
Work Step by Step
b) Increasing the exchange rate decreases demand for exported goods.
