Chapter 15 Flashcards
Mundell-Fleming model
The IS-LM model for a small open economy
Floating exchange rates
An exchange rate that the central bank allows to change in response to changing economic conditions and economic policies
What does a fiscal expansion do to a small open economy under floating exchange rates?
Pushes the IS* curve to the right, raising the exchange rate but leaving income unchanged
What does a monetary expansion do to a small open economy under floating exchange rates?
Pushes the LM* curve to the right, lowering the exchange rate and increasing income
What does a trade restriction do to a small open economy under floating exchange rates?
Shifts the NX curve outwards which shifts the IS* curve outwards, increasing the exchange rate but keeping income constant
Fixed exchange rates
An exchange rate that is set by the central bank’s willingness to buy and sell the domestic currency for foreign currencies at a predetermined price
What does a fiscal expansion do to a small open economy under fixed exchange rates?
Shifts the IS* curve to the right, causing the central bank to shift the LM* curve to the right so that exchange rates are the same but income increases
What does a monetary expansion do to a small open economy under fixed exchange rates?
Shifts the LM* curve to the right, but in order to maintain the exchange rate the LM* curve must eventually move back to its initial position
What do trade restrictions do to a small open economy under fixed exchange rates?
Shifts the IS* curve to the right, causing the central bank to shift the LM* curve to the right so that exchange rates are the same but income increases
What is the effect of an increase in the risk premium?
Shifts the IS* curve to the left, and the increase in interest rate suggests higher income, shifting LM* to the right so that there is depreciation with higher income
What does the expectation that a currency will lose value in the future do?
Causes the currency to lose value
Devaluation
An action by the central bank to decrease the value of a currency under a system of fixed exchange rates
Revaluation
An action undertaken by the central bank to raise the value of a currency under a system of fixed exchange rates
Trilemma of international finance
The fact that a nation cannot simultaneously have free capital flows, a fixed exchange rate, and independent monetary policy
What does a fiscal expansion in a large open economy do in the Mundell-Fleming model?
Shifts the IS curve to the right, increasing the interest rate, decreasing net capital outflow, reducing net exports and increasing the exchange rate
What does a monetary expansion in a large open economy do in the Mundell-Fleming model?
Shifts the LM curve to the right, decreasing the interest rate, increasing net capital outflow, increasing net exports and lowering the exchange rate
How do policy effects in the large open economy in the Mundell-Fleming model compare to a closed economy or small open economy?
The overall effect is an average of the two
