MI 4: Policy Trilemma and Fixed v. Floating e

Question 1

Trilemma of international finance

Answer 1

1. free capital flows
2. independent monetary policy
3. fixed exchange rates
   - countries can only choose 2 (US 1 and 2, China 2 and 3)

Question 2

dollarizaiton

Answer 2

• adopting the USD in other countries, one direct form of fixed e
• USD stable, but gives up monetary policy
• happens because of hyperinflation (Zimbabwe, Ecuador, Argentina)

Question 3

Floating e, large open economy (US)

Answer 3

• US can affect r*
• IS-LM: If M increases, LM shifts out, r decreases, I increases, Y increases
• IS-LM: M increases, LM* shifts out, e decreases, NX increases

Question 4

effect on small open economy

Answer 4

if r(us) decreases, r* decreases, Peru’s LM* shifts in, e(peru) increases, NX peru decreases
simpler:
r(US) decreases, e(US) decreases, e(Peru) increases