4. In a small, open, Mundell-Fleming world, describe changes in aggregate output, the exchange rate, and the trade balance in response to the following under a flexible exchange rate system:
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a. An increase in the demand for a country’s exports.
b. Increase in government spending. What’s your conclusion about the effectiveness of fiscal policy under a flexible exchange rate and why?
c. The monetary authority increases the money supply. What’s your conclusion about the effectiveness of monetary policy under a flexible exchange rate and why?
5. Write down an expression for the real exchange rate between two countries as a function of the relative price levels and the nominal exchange rate.
a. Now, derive an expression for the percent change in the nominal exchange rate as a function of the percent change in the real exchange rate and the respective inflations. Show your work.
b. Next, use the Fisher equation to relate the real and nominal interest rates to the percent change in the nominal exchange rate. Show your work.
c. Next, assume there’s an added risk premium to the foreign country’s nominal rate (think Fisher equation with an added term). What happens to the percent change in the nominal exchange rate if the risk premium increases? What happens if it falls? Show your work. Get Economics homework help today
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