Use the Mundel Fleming model to compare and contrast the effects of an expansionary fiscal policy in a small open economy in the case of floating exchange rates and in the case of fixed exchange rates. Do this both for the short run, by framing your analysis in the IS-LM context, and for the long run, by using the AD-AS framework alongside the IS-LM one. [Hint:the Mundell Fleming model is given by: Y = C(Y– T) + I(r*) + G+ NX(e) IS*, M/P= L(r*, Y) LM*. eP where & = is the real exchange rate. P+ Remember that in the short run the price is assumed constant, however in the long run it is allowed to change. This implies that in the long run the real exchange rate can change even if the nominal exchange rate is fixed].

Use the Mundel Fleming model to compare and contrast the effects of an expansionary fiscal policy in a small open economy in the case of floating exchange rates and in the case of fixed exchange rates. Do this both for the short run, by framing your analysis in the IS-LM context, and for the long run, by using the AD-AS framework alongside the IS-LM one. [Hint:the Mundell Fleming model is given by: Y = C(Y– T) + I(r) + G+ NX(e) IS, M/P= L(r, Y) LM. eP where & = is the real exchange rate. P+ Remember that in the short run the price is assumed constant, however in the long run it is allowed to change. This implies that in the long run the real exchange rate can change even if the nominal exchange rate is fixed].

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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In a large open economy, the IS curve has been given by Sd(r)-Id(r)=NX(e), where e is the real exchange rate that is positively related to the real interest rate r. Can you illustrate why the IS curve is downward sloping? That is, as Y increases, the real interest rate r is lower in equilibrium.
In the short run of a model with sticky prices, a reduction in the money supply raises the nominal interest rate and appreciates the currency. In this case the country's expected real interest rate will In addition, the real exchange rate, after initially will subsequently The latter movement of the real exchange rate satisfies the real interest parity condition which indicates that a country's currency will be expected to undergo a real depreciation when its real interest rate ▼real interest rates elsewhere.
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Using the IS-LM graph as well as the related equations and assuming an open economy with flexible exchange rates, illustrate graphically and explain carefully what effect an expansionary monetary policy will have on domestic interest rate, domestic output, and US exports, imports and trade balance. Clearly label all curves and clearly label the initial and final equilibria.
Assume that the expected future exchange rate is unchanged and that the central bank holds the real money supply fixed. Draw an IS-LM-IP diagram to show the effect of the drop in consumer confidence. Label all axes and curves and mark all the values and equilibrium points appropriately.
Assume floating exchange rates, and that after the election, the new government follows a new policy and constructs roads, bridges, and five new airports. Explain and illustrate the impact of such policy on total output, interest rates, and exchange rates under the Mundell-Flemming model
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Assume that prices are sticky in the short run. Use the MM-FX model to demonstrate the effects of each event below. After explaining your reasoning, answer clearly whether there is exchange rate overshooting in each case. In addition, display the time paths of the dollar interest rate, the euro interest rate, and the dollar-euro exchange rate. a) The US central bank decreases money supply by 5% and reverses the policy in three months. b. The US central bank decreases money supply by 5% and reverses the policy in three months. At the same time, US output declined by 2% over the same three-month period. Assume that the elasticity of money demand with respect to output is 1. Note:- Do not provide handwritten solution. Maintain accuracy and quality in your answer. Take care of plagiarism. Answer completely. You will get up vote for sure.
Imports and short-run output: In addition to depending on the exchange rate (and therefore on the interest rate), imports may depend on short-run output: when the economy is booming, consumers tend to demand more foreign goods. To incorporate this result into our short-run model, suppose the new net exports equation is Derive the IS curve with this new equation, and explain how it differs from the standard IS curve in the short-run model.
Consider the open-economy short run model. Suppose that the sensitivity of investment to interest rates is b'ib¯i =0.38, and the sensitivity of net exports to interest rates is b¯nxb¯nx=0.13. If the foreign interest rate rises by 2.52 percentage points and the domestic interest rate rises by 0.22 percentage points, by how much does short-run output change? Report your answer in percentage points to 2 decimal places.
In an open economy, and given a horizontal LM curve, which one of the following statements is correct regarding expansionary fiscal policy action? (a) An increase in government spending will lead to an increase in output and demand, the exchange rate will depreciate and exports will decrease; (b) A decrease in taxes will decrease aggregate spending, the exchange rate will depreciate and net exports will increase; (c) An increase in government spending will lead to an increase in output and demand, the exchange rate will remain unchanged and imports will increase; (d) A decrease in taxes will increase output and demand, the exchange rate will depreciate and net exports will increase.
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?