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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?