8. In a small open economy, net exports NX depend negatively on domestic in- come Y and negatively on the real exchange rate & eP/P, where e is the nom- inal exchange rate (the foreign-currency price of domestic currency), and Pand P* are the domestic- and foreign-currency prices of domestically and foreign- produced goods, respectively. Assume initially that both P and P* are fixed. There is perfect mobility of capital, so balance-of-payments equilibrium requires that ii, where i and i are the domestic and foreign interest rates. Assume the economy adopts a flexible exchange rate regime. (a) Using the IS-LM-BP model, carefully explain whether monetary policy and/or fiscal policy can succeed in raising the economy's GDP. Now assume instead that the economy adopts a fixed exchange rate regime. (b) For each of the policies below, explain what foreign-exchange market intervention is required to support the fixed exchange rate, and whether the policy would succeed in raising GDP:
8. In a small open economy, net exports NX depend negatively on domestic in- come Y and negatively on the real exchange rate & eP/P, where e is the nom- inal exchange rate (the foreign-currency price of domestic currency), and Pand P* are the domestic- and foreign-currency prices of domestically and foreign- produced goods, respectively. Assume initially that both P and P* are fixed. There is perfect mobility of capital, so balance-of-payments equilibrium requires that ii, where i and i are the domestic and foreign interest rates. Assume the economy adopts a flexible exchange rate regime. (a) Using the IS-LM-BP model, carefully explain whether monetary policy and/or fiscal policy can succeed in raising the economy's GDP. Now assume instead that the economy adopts a fixed exchange rate regime. (b) For each of the policies below, explain what foreign-exchange market intervention is required to support the fixed exchange rate, and whether the policy would succeed in raising GDP:
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Question
![8. In a small open economy, net exports NX depend negatively on domestic in-
come Y and negatively on the real exchange rate & = = eP/P*, where e is the nom-
inal exchange rate (the foreign-currency price of domestic currency), and P and
P* are the domestic- and foreign-currency prices of domestically and foreign-
produced goods, respectively. Assume initially that both P and P* are fixed.
There is perfect mobility of capital, so balance-of-payments equilibrium requires
that i i*, where i and it are the domestic and foreign interest rates.
Assume the economy adopts a flexible exchange rate regime.
=
(a)
Using the IS-LM-BP model, carefully explain whether monetary
policy and/or fiscal policy can succeed in raising the economy's GDP.
Now assume instead that the economy adopts a fixed exchange rate regime.
(b)
For each of the policies below, explain what foreign-exchange
market intervention is required to support the fixed exchange rate, and
whether the policy would succeed in raising GDP:
i. Increasing the supply of money
ii. Increasing government expenditure](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fa762e458-b16a-4ce4-8dbc-32303653c9da%2Fbeff375a-a72f-4d26-9fb6-a2f8be07c78a%2Fwxv7ps_processed.jpeg&w=3840&q=75)
Transcribed Image Text:8. In a small open economy, net exports NX depend negatively on domestic in-
come Y and negatively on the real exchange rate & = = eP/P*, where e is the nom-
inal exchange rate (the foreign-currency price of domestic currency), and P and
P* are the domestic- and foreign-currency prices of domestically and foreign-
produced goods, respectively. Assume initially that both P and P* are fixed.
There is perfect mobility of capital, so balance-of-payments equilibrium requires
that i i*, where i and it are the domestic and foreign interest rates.
Assume the economy adopts a flexible exchange rate regime.
=
(a)
Using the IS-LM-BP model, carefully explain whether monetary
policy and/or fiscal policy can succeed in raising the economy's GDP.
Now assume instead that the economy adopts a fixed exchange rate regime.
(b)
For each of the policies below, explain what foreign-exchange
market intervention is required to support the fixed exchange rate, and
whether the policy would succeed in raising GDP:
i. Increasing the supply of money
ii. Increasing government expenditure
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