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This question asks you to discuss a small open economy under a floating exchange rate regime....

This question asks you to discuss a small open economy under a floating exchange rate regime.

  1. What is the definition of a small open economy? What implications does this have for the interest rate?
  2. What is the difference between fixed exchange rates and floating exchange rates?
  3. In a small open economy with floatingexchange rates, what are the effects of fiscal expansion? What are the effects of monetary expansion? Explain why
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Answer #1

1) A small open economy (SOE) is an economy that participates in international trade, but is small enough compared to its trading partners that its policies do not alter world prices, interest rates, or incomes.


2) SOE has negative repercussions on the interest rate, but will have no effect on output at flexible exchange rates, being fully offset by the negative demand effect.


3) A fixed exchange rate denotes a nominal exchange rate that is set firmly by the monetary authority with respect to a foreign currency or a basket of foreign currencies whereas, a floating exchange rate is determined in foreign exchange markets depending on demand and supply, and it generally fluctuates constantly.

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