Podcast
Questions and Answers
What effect does an increase in government spending have on the IS curve?
What effect does an increase in government spending have on the IS curve?
- It has no effect on the IS curve.
- It shifts the IS curve to the left.
- It makes the IS curve vertical.
- It shifts the IS curve to the right. (correct)
How does a higher interest rate impact net capital outflows?
How does a higher interest rate impact net capital outflows?
- It increases net capital outflows.
- It causes net capital outflows to stabilize.
- It decreases net capital outflows. (correct)
- It has no effect on net capital outflows.
What happens to net exports when the exchange rate appreciates?
What happens to net exports when the exchange rate appreciates?
- Net exports increase.
- Net exports remain unchanged.
- Net exports fluctuate unpredictably.
- Net exports decrease. (correct)
Which effect does an increase in money supply have on the LM curve?
Which effect does an increase in money supply have on the LM curve?
How does a depreciation of the currency affect net exports?
How does a depreciation of the currency affect net exports?
Why is fiscal policy less effective in a large open economy compared to a closed one?
Why is fiscal policy less effective in a large open economy compared to a closed one?
What is the effect of monetary expansion on income in an open economy?
What is the effect of monetary expansion on income in an open economy?
What role does the crowding-out effect play in fiscal policy?
What role does the crowding-out effect play in fiscal policy?
What does the IS equation in the Mundell-Fleming model primarily represent?
What does the IS equation in the Mundell-Fleming model primarily represent?
In the Mundell-Fleming model for a large open economy, what happens to net capital outflow if the domestic interest rate increases?
In the Mundell-Fleming model for a large open economy, what happens to net capital outflow if the domestic interest rate increases?
Which component in the IS equation is affected by disposable income?
Which component in the IS equation is affected by disposable income?
What is represented by CF(r) in the net capital outflow equation of the Mundell-Fleming model?
What is represented by CF(r) in the net capital outflow equation of the Mundell-Fleming model?
How does the LM equation characterize the relationship between money supply and interest rate in the Mundell-Fleming model?
How does the LM equation characterize the relationship between money supply and interest rate in the Mundell-Fleming model?
What role does government spending (G) play in the IS equation?
What role does government spending (G) play in the IS equation?
Which graph in the Mundell-Fleming model illustrates the equilibrium between goods and money markets?
Which graph in the Mundell-Fleming model illustrates the equilibrium between goods and money markets?
In the context of the Mundell-Fleming model, what happens to investment (I(r)) as the interest rate (r) rises?
In the context of the Mundell-Fleming model, what happens to investment (I(r)) as the interest rate (r) rises?
Flashcards
Exchange Rate Diagram
Exchange Rate Diagram
Illustrates exchange rate adjustments to balance net exports and net capital flows.
Fiscal Policy in Open Economy
Fiscal Policy in Open Economy
Fiscal policy (e.g., increased government spending) is less effective in a large open economy. Higher interest rates reduce investment and net exports.
IS Curve Shift (Fiscal Policy)
IS Curve Shift (Fiscal Policy)
Increased government spending or tax cuts shift the IS curve to the right, raising income and interest rates.
Net Capital Outflow (Fiscal Policy)
Net Capital Outflow (Fiscal Policy)
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Monetary Policy in Open Economy
Monetary Policy in Open Economy
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LM Curve Shift (Monetary Policy)
LM Curve Shift (Monetary Policy)
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Net Capital Outflow (Monetary Policy)
Net Capital Outflow (Monetary Policy)
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Fiscal Policy Multiplier (Open Economy)
Fiscal Policy Multiplier (Open Economy)
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Mundell-Fleming Model for Large Open Economies
Mundell-Fleming Model for Large Open Economies
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IS Equation (Goods Market)
IS Equation (Goods Market)
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LM Equation (Money Market)
LM Equation (Money Market)
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Net Capital Outflow (CF)
Net Capital Outflow (CF)
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Impact of Interest Rate on CF
Impact of Interest Rate on CF
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Exchange Rate (e)
Exchange Rate (e)
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Net Exports (NX)
Net Exports (NX)
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Large Open Economy vs. Small Open Economy
Large Open Economy vs. Small Open Economy
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Study Notes
Mundell-Fleming Model for Large Open Economies
- The model combines the IS-LM approach with the Mundell-Fleming model, used to analyze policies in large open economies like the US
- Interest rates in large open economies aren't set globally, influencing capital flows into and out of the country, affecting trade and exchange rates.
Key Components of the Model
- Goods Market (IS) Equation: Describes total spending.
- Y = C(Y - T) + I(r) + G + NX(e)
- Y = national income/output
- C(Y - T) = consumption based on disposable income
- I(r) = investment, decreasing with rising interest rates (r)
- G = government spending
- NX(e) = net exports, depending on exchange rate (e)
- Money Market (LM) Equation: Describes money supply and demand
- M/P = L(r, Y)
- M/P = real money supply (money adjusted for prices)
- L(r, Y) = money demand, depending on interest rate (r) and income (Y)
- Net Capital Outflow Equation: Links trade and capital flows
- NX(e) = CF(r)
- CF(r) = net capital outflow (how much domestic investors lend abroad minus what foreign investors lend domestically)
Analyzing Policy Impacts
- Analyzing how fiscal and monetary policies affect income, interest rates, and exchange rates in large open economies.
- IS-LM Diagram: Shows goods and money market equilibrium, determining interest rates and income.
- Net Capital Outflow Diagram: Shows how interest rates influence net capital flows.
- Exchange Rate Diagram: Shows how exchange rates adjust to balance net exports and net capital flows.
Effects of Fiscal Policy (e.g., Increased Government Spending)
- Shifting the IS Curve: Increased government spending or tax cuts shift the IS curve right, raising income and interest rates similarly to a closed economy.
- Impact on Net Capital Outflows: Higher interest rates decrease net capital outflow.
- Exchange Rate Impact: Fewer dollars flowing out cause the exchange rate to appreciate (currency strengthens).
Effects of Monetary Policy (e.g., Increased Money Supply):
- Shifting the LM Curve: Increased money supply shifts the LM curve right, lowering interest rates and raising income.
- Impact on Net Capital Outflows: Lower interest rates increase net capital outflow as investors seek higher returns abroad, leading to a depreciating exchange rate (currency weakens).
- Exchange Rate Impact: Depreciation makes domestic goods cheaper abroad, boosting net exports.
Comparing Fiscal and Monetary Policy
- Fiscal policy is less effective in large open economies due to higher interest rates decreasing investment and net exports (crowding-out effect).
- Monetary policy is more effective in large open economies because it lowers interest rates, stimulating investment, and also weakening the currency, which boosts net exports. This leads to a more significant multiplier effect.
Conclusion
- Both fiscal and monetary policies impact income, interest rates, and exchange rates in large open economies, but in different ways.
- Fiscal policy has a smaller impact due to crowding out of net exports.
- Monetary policy is more influential and includes effects on exchange rates.
- The model helps policymakers in countries like the US balance domestic and international economic goals.
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