Question

Examine the effects of a decrease in foreign output and foreign interest rate under flexible-exchange rate regime when the goal of the central bank is to achieve output stability (Hint: Use Mundell-Fleming model). What happens to the components of demand? (25 pts.)

Answer 1

according to the mundell flaming model equillibirum achived through IS , LM , AND BALANCE OF PAYMENT CURVE .When flexible exchane rate working then only monetry policy work in a country .

if a country decrease output and interest rate it affect other country in many ways .

DECREASE IN INTEREST RATE ;

If a country decrease interest rate then the money outflow happen . other country will not show any interest in investment in that country .increase capital inflow in local country . that appriciate local currency and boost import by shifting IS curve to the left BOP Curve shift downward and exchange rate change enough to intersect new BOP And unchanged LM CURVE . With this domestic or global interest rate become same . here is curve is representing demad or consumption also .