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CHAPTER 15: MONETARY AND FISCAL POLICY IN THE
OPEN ECONOMY
Additional Questions
Essay Questions and/or Problems:
1. In an open economy, then what is depicted by the LM, IS, and BOP curves?
2. If perfect capital mobility holds in a fixed exchange rate system, then can monetary or
fiscal policy influence output? Explain.
3. Suppose that the US and Europe maintain a fixed exchange rate between themselves. If
inflation in the US is 3% and in Europe it is 1%, what would happen to the trade balances
between these two countries? Could these countries maintain their fixed exchange rates
forever? Why or why not?
4. Under what conditions is the balance of payments schedule in the open economy IS-LM
model upward sloping? Horizontal?
5. Given the assumptions of perfect capital mobility and a fixed exchange rate system, discuss
the effects of an increase in the money supply. Provide a graph of the open economy IS-LM
model to illustrate.
6. Under perfect capital mobility, what would occur if the interest rate on dollar-denominated
bonds amounts to 6.1 percent and the interest rate on euro-denominated bonds adjusted for
changes in the exchange rate is expected to be 5.0 percent? Explain.
7. (a) You are the economics advisor of Sweden, a country that is not a member of the
European Union but trades quite a bit with EU countries and with whom there is a high
degree of capital mobility. Suppose that the members of the European Union enact a large
tax cut financed by a large increase in their deficit. What should happen to exchange rates
in Sweden? What should happen to their trade balance?
(b) If you are very interested in keeping the Swedish exchange rate constant at the rate it
was before the EU tax cut, what specific policy would you recommend to do this to keep
your currency from becoming overvalued or undervalued?
8. (a). Show the equation for the BP schedule.
(b). Discuss, in detail, what the term F represents.
Additional Essay Questions and/or Problems:
9. Assuming perfect capital mobility, graphically show an increase in the money stock.
Compare and contrast your answer depending upon whether exchange rates are fixed or
flexible.
10. Assuming imperfect capital mobility, graphically show an increase in the money stock.
Compare and contrast your answer depending upon whether exchange rates are fixed or
flexible.
11. Assuming flexible exchange rates, graphically show an increase in the money stock.
Compare and contrast your answer depending upon whether capital mobility is perfect or
imperfect.
12. Assuming fixed exchange rates, graphically show an increase in the money stock. Compare
and contrast your answer depending upon whether capital mobility is perfect or imperfect.
13. Assuming perfect capital mobility, graphically show an increase in government spending.
Compare and contrast your answer depending upon whether exchange rates are fixed or
flexible.
14. Assuming imperfect capital mobility, graphically show an increase in government
spending. Compare and contrast your answer depending upon whether exchange rates are
fixed or flexible.
15. Assuming flexible exchange rates, graphically show an increase in government spending.
Compare and contrast your answer depending upon whether capital mobility is perfect or
imperfect.
16. Assuming fixed exchange rates, graphically show an increase in government spending.
Compare and contrast your answer depending upon whether capital mobility is perfect or
imperfect.
17. Explain the conditions under which a change in monetary policy would have no impact on
income within the open economy Mundell-Fleming model.
18. Suppose that a open economy with perfect capital mobility chooses to impose a tariff on all
of its imports. Analyze the impact of these tariffs under fixed and flexible exchange rate
systems.
Multiple-Choice Questions:
1. An open-economy model is one that
2. Within a fixed exchange rate system, the effect of an expansionary fiscal policy action on
the balance of payments will be to
3. A fall in the demand for U.S. exports would result in a rise in the exchange rate when
4. A reduction in national savings will
5. An exogenous increase in the country’s trade balance shifts the
6. Which of the following statements is (are) correct? The Mundell-Fleming model is
7. Assuming imperfect perfect capital mobility, the BP schedule is
8. According to the balance of payments schedule, as the level of income rises
9. A rightward shift of the BP curve occurs with a
10. Assuming perfect capital mobility and a fixed exchange rate, then an increase in
government spending shifts
11. The BP schedule shows the combinations of the interest rate and income
12. Assume perfect capital mobility. Under a fixed exchange rate system, expansionary fiscal
policy causes the value of the dollar to _____, while expansionary monetary policy causes
the value of the dollar to _____.
13. If exchange rates are perfectly flexible, an expansionary U.S. monetary policy will
14. Which of the following statements is (are) correct?
15. A leftward shift of the BP schedule co the result of an
16. In a closed economy, there should be a close positive relationship between
17. Under perfect capital mobility and a floating exchange rate system, expansionary fiscal
policy leads to
18. The BP schedule will be steeper the
19. In an open economy, there should be a
20. Which of the following statements is (are) correct? According to the Feldstein-Horioka
Saving Investment Puzzle
21. Assuming perfect capital mobility and flexible exchange rates, then
22. In the Mundell-Fleming model with perfect capital mobility, the domestic interest rates are
determined by
23. In an economy with perfect capital mobility, if domestic interest rates are above world
interest rates then
24. Imports depend
25. From the mid 1980s to the present, the United States
26. Assume perfect capital mobility and a fixed exchange rate system. Then, an increase in
government spending would shift the
27. A rightward shift of the BP schedule is the result of a(n)
28. Which of the following factors might make capital mobility less than perfect?
29. Empirically, there is a close positive relationship between domestic savings and investment.
This is consistent with what we should expect to observe in
30. Under perfect capital mobility, an increase in world interest rates will
31. The balance of payments schedule can be expressed as
32. Under perfect capital mobility
33. Under perfect capital mobility and flexible exchange rates, monetary policy works through
the
34. An exogenous increase in domestic investment will
35. In the Mundell-Fleming model, regardless of whether the economy has perfect capital
mobility or not, an increase in the money supply
36. In the Mundell-Fleming model, the exogenous variables are
37. Assuming imperfect capital mobility and a fixed exchange rate, then an expansionary
monetary policy
38. Assume perfect capital mobility. Under a fixed exchange rate system, expansionary fiscal
policy causes income to _____, while under flexible exchange rates expansionary fiscal
policy causes income to _____.
39. The net capital inflow is
40. A depreciation of the dollar under perfect capital mobility would cause
41. In the Mundell-Fleming model, all of the following are true EXCEPT:
42. In the Mundell-Fleming model with a floating exchange rate and perfect capital mobility,
an increase in the money supply does all of the following EXCEPT:
43. In the Mundell-Fleming model with a floating exchange rate and perfect capital mobility,
expansionary fiscal policy does all of the following EXCEPT:
44. Dollarization by a foreign country is another form of:
45. Under perfect capital mobility, fiscal policy has the largest impact on the income under:
46. Under perfect capital mobility, monetary policy has the largest impact on the income under:
47. Which of the following factors would increase capital mobility?
48. The BP curve shifts to the left when:
49. Assuming perfect perfect capital mobility, the BP schedule is
50. In an open economy, there should be a close positive relationship between