Consider the Mundell-Fleming short-run model of a small open economy under fixed exchange rates described by the following equations (1) through (7). Assume that there are free capital flows and that interest rate parity holds so that r = r*where r = 5 is the world interest rate. (1) C = 400+0.8 (Y-T); (2) I=850-60r"; (3) G=1200; (4) T=1000+ 0.25 Y; (5) NX = 600-200e; (6) Y=C+I+G+NX; (7) (M/P)=0.5Y -50r. Equation (6) is the goods market equilibrium condition (IS* equation), while equation (7) is the LM equation. The fixed domestic price level is P = 2 while the foreign price level is P=1. In equation (5), e is the nominal exchange rate. Suppose that the Central Bank decides to fix the nominal exchange rate at efix= 3. Then the domestic money supply M and the equilibrium output level Y* must be such that a) M =5000; Y* - 5500. b) M=6250; Y = 6750 c) M-2875: Y-3375 Od) Y* stays constant as the Central Bank adjusts the money supply to stabilize output.
Consider the Mundell-Fleming short-run model of a small open economy under fixed exchange rates described by the following equations (1) through (7). Assume that there are free capital flows and that interest rate parity holds so that r = r*where r = 5 is the world interest rate. (1) C = 400+0.8 (Y-T); (2) I=850-60r"; (3) G=1200; (4) T=1000+ 0.25 Y; (5) NX = 600-200e; (6) Y=C+I+G+NX; (7) (M/P)=0.5Y -50r. Equation (6) is the goods market equilibrium condition (IS* equation), while equation (7) is the LM equation. The fixed domestic price level is P = 2 while the foreign price level is P=1. In equation (5), e is the nominal exchange rate. Suppose that the Central Bank decides to fix the nominal exchange rate at efix= 3. Then the domestic money supply M and the equilibrium output level Y* must be such that a) M =5000; Y* - 5500. b) M=6250; Y = 6750 c) M-2875: Y-3375 Od) Y* stays constant as the Central Bank adjusts the money supply to stabilize output.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Consider the Mundell-Fleming short-run model of a small open economy under fixed
exchange rates described by the following equations (1) through (7). Assume that
there are free capital flows and that interest rate parity holds so that r = r* where r*
5 is the world interest rate. (1) C = 400+0.8 (Y-T); (2) I=850-60r*; (3) G=1200;
(4) T=1000+ 0.25 Y; (5) NX = 600-200e; (6) Y=C+I+G+NX; (7) (M/P)= 0.5Y
-50r*. Equation (6) is the goods market equilibrium condition (IS* equation), while
equation (7) is the LM equation. The fixed domestic price level is P = 2 while the
foreign price level is P*=1. In equation (5), e is the nominal exchange rate. Suppose
that the Central Bank decides to fix the nominal exchange rate at efix = 3. Then the
domestic money supply M and the equilibrium output level Y* must be such that
a) M =5000; Y* =5500.
b) M=6250; Y* = 6750
c) M-2875; Y-3375
Od)
Y* stays constant as the Central Bank adjusts the money supply to stabilize
output.
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