Exam 13: The Open Economy Revisited: the Mundellfleming Model and the Exchange-Rate Regime

The "impossible trinity" refers to the idea that it is impossible for a country to simultaneously have:

If the exchange rate of currency A is fixed to a unit of currency B, then a potential problem for the central bank in charge of currency A is:

Exhibit: IS*-LM* A small open economy with a fixed exchange rate e₂ is initially at equilibrium A with and equilibrium output Y₁. If there is an increase in government spending to the new equilibrium will be at _____, holding everything else constant.

In a small open economy with a fixed exchange rate, if the country devalues its currency, then in the new short-run equilibrium the exchange rate _____, and the LM* curve shifts to the _____.

In the Mundell-Fleming model with flexible exchange rates, an increase in the price level results in a(n) _____ in the real exchange rate and a(n) _____ in net exports.

In the Mundell-Fleming model, if the economy is operating at or below the natural level in the short run, then in the long run the price level will fall, the exchange rate will _____, and net exports will _____ to restore the economy to its natural rate.

Country risk included in the risk premium in interest rates refers to the:

Under a floating system, the exchange rate:

If there is a fixed-exchange-rate system, then in the short run described by the Mundell-Fleming model:

The "impossible trinity" refers to the idea that a country can simultaneously pursue only two of the three following policies: free international-capital flows, monetary policy for domestic stabilization, and a fixed exchange rate. For each of the following combinations indicate what the economy gives up by selecting the combination and why the omitted policy cannot be achieved: a.a fixed exchange rate and free international-capital flows b.a monetary policy for domestic stabilization and a fixed exchange rate c.a monetary policy for domestic stabilization and free international-capital flows

In a large open economy with a floating exchange rate, such as in the United States, in the short run a monetary contraction:

A speculative attack on a currency occurs when:

If the exchange rate is allowed to have a direct effect on the consumer price index, then a drop in government spending leads to:

The principal economic loss when a country dollarizes is the loss of:

The demand for Canadian goods from other countries is likely to increase if:

Assume that the LM curve for a small open economy with a floating exchange rate is given by Y = 200r - 200 + 2 (M / P), while the IS curve is Y = 400 + 3G - 2T + 3NX - 200r. The function for NX is NX = 200 - 100e, where e is the exchange rate. The price level (P) is fixed at 1.0. The international interest rate is r^* = 2.5 percent. ​ a.Using the LM curve, find the equilibrium level of Y in the small open economy, if M = 100. b.Given this value of Y, if G = 100 and T = 100, what must be the equilibrium value of NX? c.If this value of NX is to be achieved, what must be the equilibrium exchange rate, e?

The introduction of automatic teller machines, which reduces the demand for money, will, according to the Mundell-Fleming model with fixed exchange rates, lead to:

The goods produced in Canadian industries may be made more competitive in world markets by:

Suppose the Minister of Finance cuts government spending in order to balance the budget. Use the Mundell-Fleming model with floating exchange rates to illustrate graphically the short-run impact of the cuts in government spending on the dollar exchange rate and output in Canada. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

One argument favouring a fixed-exchange-rate system is that it: