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In a small, open, Mundell-Fleming world, describe changes in aggregate output, the exchange rate, and the trade balance in response to the following...
In a small, open, Mundell-Fleming world, describe changes in aggregate output, theexchange rate, and the trade balance in response to the following under a fixedexchange rate system:a. An increase in the demand for a country’s exports.b. Increase in government spending. What’s your conclusion about theeffectiveness of fiscal policy under a fixed exchange rate and why?c. The monetary authority increases the money supply. What’s your conclusionabout the effectiveness of monetary policy under a fixed exchange rate andwhy?4. In a small, open, Mundell-Fleming world, describe changes in aggregate output, theexchange rate, and the trade balance in response to the following under a flexibleexchange rate system:a. An increase in the demand for a country’s exports.b. Increase in government spending. What’s your conclusion about theeffectiveness of fiscal policy under a flexible exchange rate and why?c. The monetary authority increases the money supply. What’s your conclusionabout the effectiveness of monetary policy under a flexible exchange rate andwhy?5. Write down an expression for the real exchange rate between two countries as afunction of the relative price levels and the nominal exchange rate.a. Now, derive an expression for the percent change in the nominal exchangerate as a function of the percent change in the real exchange rate and therespective inflations. Show your work.b. Next, use the Fisher equation to relate the real and nominal interest rates tothe percent change in the nominal exchange rate. Show your work.c. Next, assume there’s an added risk premium to the foreign country’s nominalrate (think Fisher equation with an added term). What happens to thepercent change in the nominal exchange rate if the risk premium increases?What happens if it falls? Show your work.
Answer:1) Fixed Exchange rate:(a) Due to an increase in demand for country’s export, the net export schedule wouldalso shift. This would shift the IS curve to the right and due to this LM...