Question

Flexible exchange rates and responses to changes in foreign macroeconomic policy. Suppose there is an expansionary fiscal policy in the foreign country that increases Y*, and at the same time the foreign central bank raises i* .

(a) In an IS-LM-IP diagram (IP for the interest parity relation), show the effects of the increase in foreign output Y* and the increase in the foreign interest rate i* , on domestic domestic output Y and the exchange rate (E), when the domestic central bank leaves the policy interest rate unchanged. Briefly explain in words.
(b) In an IS-LM-IP diagram, show the effects of the increase in Y* and the increase in i* on the domestic output (Y ) and the exchange rate (E), when the domestic central bank matches the increase in the foreign interest rate with an equal increase in the do-mestic interest rate. Briefly explain in words
(c) In an IS-LM-IP diagram, show the required domestic monetary policy following the increase in Y* and the increase in i* , if the goal of domestic monetary policy is to leave domestic output Y unchanged. Briefly explain in words. When might such a policy be necessary?

Answer 1

The answer is letter C.

Step-by-step explanation:

In an IS-LM-IP diagram, show the required domestic monetary policy following the increase in Y* and the increase in i* , if the goal of domestic monetary policy is to leave domestic output Y unchanged. Briefly explain in words. When might such a policy be necessary?

IS-LM-BP-Model was formulated by Mundell and Fleming. They were both economists and they created two kinds of analysis in the IS-LM-BP model according to the exchange rate regimes fixed or flexible. Point above/ below the BP curve is trade surplus/ deficit.

Foreign central bank rases i, interest rate differential reduces, exchange rate depreciates, trade balance improves, IS shifts rightwards, point above BP curve, so ,income rises because of expansionary fiscal policy also, excess demand for money , interest rate, rises, investiment decreases, income decreases.