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International Economics (International Finance Part) Problem set 3 From Dernburger, Thomas, Global Macroeconomics 1. In an open economy in equilibrium, a deficit in the government budget must equal the sum of the surpluses in the private and foreign sectors. Why is this? If government purchases rise to increase the budget deficit, how do income changes act to generate offsetting increases in the surpluses of the other sectors? 2. What is the small-open-country multiplier? Why is it less than the closed-economy multiplier? 3. What is the effect on net exports of an autonomous increase in exports? Is it possible for income to rise by enough to generate an equivalent increase in imports? 4. What is the effect on net exports of an autonomous increase in investment or government purchases? Would it be possible for these changes to leave net exports unaffected? 5. In a fixed price Keynesian framework, why is the value of the expenditure multiplier in a large open economy is greater than the small-economy multiplier but lower than the closed-economy multiplier? 6. If we have fixed exchange rates and rigid prices, we can have either equilibrium at full employment or equilibrium in the balance of payments. But we can’t have both, except by accident. Why? What would happen if price levels became flexible? What would happen if the exchange rate were free to fluctuate? 7. In the absence of capital mobility, monetary and fiscal policies cannot raise national income without causing a balance-of-payments deficit. Why? What would this imply about the effectiveness of the policies under fixed exchange rates? What would it imply under flexible exchange rates? 8. Under fixed exchange rates the LM curve shifts automatically in response to the balance of payments. Under flexible exchange rates the IS and FB curves shift automatically. Explain why. 9. Assume that capital mobility is perfect. Then analyze a. the effect of expansionary monetary policy on national income under fixed exchange rates. b. the effect of expansionary fiscal policy on national income under fixed exchange rates. c. the effect of expansionary monetary policy on national income under flexible exchange rates. d. the effect of expansionary fiscal policy on national income under flexible exchange rates. 10. Why is the proposition that monetary policy cannot raise the level of income under fixed exchange rates independent of the degree of capital mobility?