Exercise 3The IS-LM model extension to the open economy is known as the Mundell-Fleming model. Theequilibrium in the goods market (IS) is given byY = C+1+G+ NXThe LM is given by i= i. And the interest parity relation given by:E=E° (1+i)/(1+i*)What is the impact of a reduction in domestic taxes on output, the domestic interest rateand the nominal exchange rate?а.b. Now assume there is a peg in the nominal exchange rate, such that the country is in afixed exchange rate regime. How does your answer in (a) change in this case?С.Going back to the flexible exchange rate regime, what is the impact of an increase indomestic interest rate on output and the nominal exchange rate?d. In an open economy, is the impact of a change in the domestic interest rate on output largeror smaller than in a similar one which is a closed economy?

The Mundell-Fleming model is a financial framework that analyzes the relationship between exchange…

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IS-LM model

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Exercise 3
The IS-LM model extension to the open economy is known as the Mundell-Fleming model. The
equilibrium in the goods market (IS) is given by
Y = C+1+G+ NX
The LM is given by i= i. And the interest parity relation given by:
E=E° (1+i)/(1+i*)
What is the impact of a reduction in domestic taxes on output, the domestic interest rate
and the nominal exchange rate?
а.
b. Now assume there is a peg in the nominal exchange rate, such that the country is in a
fixed exchange rate regime. How does your answer in (a) change in this case?
С.
Going back to the flexible exchange rate regime, what is the impact of an increase in
domestic interest rate on output and the nominal exchange rate?
d. In an open economy, is the impact of a change in the domestic interest rate on output larger
or smaller than in a similar one which is a closed economy?

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Step 4: Explain the impact of an increase in domestic interest rate on output and the nominal exchange rate

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