In the Mundell-Fleming Model, under a fixed exchange rate regime, which of the following policies is generally considered effective at increasing output?A.Expansionary fiscal policyB.Contractionary fiscal policyC.Expansionary monetary policyD.Contractionary monetary policy
Question
In the Mundell-Fleming Model, under a fixed exchange rate regime, which of the following policies is generally considered effective at increasing output?A.Expansionary fiscal policyB.Contractionary fiscal policyC.Expansionary monetary policyD.Contractionary monetary policy
Solution
In the Mundell-Fleming Model, under a fixed exchange rate regime, the policy that is generally considered effective at increasing output is A. Expansionary fiscal policy.
Here's a step-by-step explanation:
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The Mundell-Fleming Model is an economic model that explains the relationship between exchange rates, output (or income), and interest rates in an open economy.
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Under a fixed exchange rate regime, the country's central bank intervenes in the foreign exchange market to keep the exchange rate constant.
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An expansionary fiscal policy involves increasing government spending or decreasing taxes. This leads to an increase in aggregate demand, which in turn increases output and income.
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However, an increase in income leads to an increase in money demand, which pushes up the interest rate.
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The higher interest rate attracts foreign capital, leading to an appreciation of the domestic currency. But since the exchange rate is fixed, the central bank must intervene by buying foreign currency and increasing the money supply.
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The increase in the money supply brings the interest rate back down, but the increase in aggregate demand and output remains.
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Therefore, under a fixed exchange rate regime, expansionary fiscal policy is effective at increasing output.
On the other hand, monetary policy (both expansionary and contractionary) is generally ineffective under a fixed exchange rate regime because the central bank does not have independent control over the money supply.
Similar Questions
Which of the following statements about the Mundell-Fleming model is incorrect？A.Under a floating exchange rate regime, capital is fully mobile and expansionary fiscal spending reduces the country's net exports by an equivalent amount.B.If price level changes are allowed, the AD-AS model should be used to analyse the effectiveness of fiscal and monetary policies.C.Under a fixed exchange rate regime, capital is completely immobile and expansionary monetary policy leads to a drain on foreign exchange reserves.D.Under a fixed exchange rate regime, an expansion of fiscal policy leads to an increase in the money supply.
Select the statement which incorrectly explain the behavior of the economic impact under Mundell-Fleming Model.A.1. In a small open economy with fixed exchange rate, IS* and LM* curves will shift to right under expansionary fiscal policy and output is increased.B.1. In a small open economy with fixed exchange rate, monetary policy is ineffective while fiscal policy is effective.C.1. In a small open economy with floating exchange rate, monetary policy is effective while fiscal policy is ineffective.D.1. In a small open economy with floating exchange rate, IS* curve will shift to right under expansionary fiscal policy and output is increased.
Which of the following will likely occur in a small open economy with a fixed exchange rate regime under expansionary monetary policy according to the Mundell-Fleming Model?A.The currency will appreciateB.The currency will depreciateC.There will be no impact on the currency valueD.The IS* curve will shift to the right
According to the Mundell-Fleming model, expansionary monetary policy leads to what? A. Higher interest rates and a stronger currency B. Lower interest rates and a weaker currency C. Higher interest rates and a weaker currency D. Lower interest rates and a stronger currency
According to the Mundell-Fleming Model, which of the following statements is true?This is a multi answer question. You can select one or more options as the answer.A.In a flexible exchange rate system, an increase in the interest rate will lead to an appreciation of the domestic currency.B.An increase in government spending in a small open economy will always lead to a depreciation of currency.C.Under fixed exchange rates, a decrease in the money supply will result in a depreciation of currency.D.In a closed economy, changes in fiscal and monetary policy have no impact on the exchange rate.
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