Purchase Solution

Fiscal Policy, Fixed Exchange Rates, and High Capital Mobility

Not what you're looking for?

Ask Custom Question

Analyze the following statement: "Given an open economy with high capital mobility, fiscal policy is strengthened under fixed exchange rates."

Purchase this Solution
Solution Summary

Fiscal policy will be effective under the fixed exchange rate regime with high capital mobility. Initial increment in interest rate as a result of fiscal expansion, will attract more capital inflows. This capital inflow will be more than enough to finance higher imports resulting from higher income due to fiscal expansion. The overall balance of payment will be in surplus. High level of capital will drag down the interest rate. Investment will increase and income will further increase. Therefore, in total the increment in income is higher than the normal case of fiscal expansion in a closed economy, or in the open economy with low capital mobility.

Solution Preview

The statement is true.
refer to the attached graph to support the explanation, where:
r = interest rate
Y = income
LM = LM curve
IS = IS curve
BP = balance of payment

With fiscal policy expansion, IS will shift to IS'. Both interest rate and income increase to ...

Purchase this Solution
Free BrainMass Quizzes
Pricing Strategies

Discussion about various pricing techniques of profit-seeking firms.

Elementary Microeconomics

This quiz reviews the basic concept of supply and demand analysis.

Basics of Economics

Quiz will help you to review some basics of microeconomics and macroeconomics which are often not understood.

Economic Issues and Concepts

This quiz provides a review of the basic microeconomic concepts. Students can test their understanding of major economic issues.

Economics, Basic Concepts, Demand-Supply-Equilibrium

The quiz tests the basic concepts of demand, supply, and equilibrium in a free market.

View More Free Quizzes
Related BrainMass Solutions

  • system of floating (flexible) exchange rates and high capital mobility

    300129 system of floating exchange rates and high capital mobility Under a system of floating (flexible) exchange rates and high capital mobility, is monetary policy or fiscal policy better suited for promoting internal balance? Why?

  • Several Problems

    Monetary and Fiscal Policy with Fixed Exchange Rates An economy with fixed exchange rates is much more restricted in its monetary and fiscal policies than one with flexible exchange rates.

  • perfect capital mobility

    Countries that have fixed exchange rates between their currencies are committed to having similar inflation rates in the long run. This imposes a discipline effect on countries that otherwise would tend to have high inflation rates.

  • Difference in fixed exchange rate and floating rate systems

    - Floating exchange rates leave countries free to engage in competitive currency depreciations. Fixed Exchange Rate: - requires strict controls over capital movements.

  • countries have flexible exchange rates and highly mobile capital

    284199 countries have flexible exchange rates and highly mobile capital A.) What are the effects of one country pursuing expansionary fiscal policy and tight monetary policy? B.)

  • Implication of monetary policy under fixed exchange-rate system on balance of payment

    Expansionary monetary policy in the fixed exchange-rate system will worsen the balance of payment account. However, the extent of worsening of the balance of payment account depends on the degree of international capital mobility.

  • flexible vs fixed exchange rates

    While it does cause problems for fiscal policy implementation, monetary policy is considered superior in many ways and few countries are willing to give it up.

  • opportunity cost

    2.Why is it both an advantage and a disadvantage that fixed exchange rates limit the government's ability to carry out monetary and fiscal policy? Macro questions 1.What is the opportunity cost of holding large quantities of cash?

  • economic importance of currency exchange

    Thus monetary policy is ineffective due to the balance of payments feedback. In an open economy, fiscal policy impacts the exchange rate and the trade balance.

View More Related Solutions