Question

In the Mundell prescription for monetary and fiscal policy under fixed exchange rates, expansionary fiscal policy and contractionary monetary policy would be recommended if a country were faced with

Select one:

a. unemployment and a balance-of-payments deficit.

b. unemployment and a balance-of-payments surplus.

c. inflation and a balance-of-payments deficit.

d. inflation and a balance-of-payments surplus.

Answer 1

Option A.

• In the Mundell prescription for monetary and fiscal policy under fixed exchange rates, both fiscal and monetary policies can be used simultaneously at the same time.
• According to the mundell model, when exapansionary fiscal policy of increasing spending and decreasing tax rates is combined with a contractionary monetary policy of decreasing money supply, then a country can eliminate unemployment and balance of payment deficit together.
• Higher interest rates and higher spending with lower taxes will balance out the aggregate demand within the economy.
• This will eliminate the problem of deficits that arise when exchange rates are fixed.