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What are the endogenous variables in a model of a fixed exchange rate system?
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Output (Y), interest rate (I), and money supply (M).
Explain how changes in interest rates impact the domestic currency's value in a floating exchange rate system.
Changes in interest rates impact the domestic currency's value through the interest parity condition.
What role does fiscal policy play in potentially leading to crowding out in a floating exchange rate system?
Fiscal policy might lead to crowding out because central bank actions could offset government spending effects by adjusting the interest rate.
What are the key characteristics of a floating exchange rate system in an open economy?
Central bank has control over monetary policy, interest rates can be adjusted, fiscal policy is less effective due to potential crowding out, and changes in interest rates affect all components of aggregate demand except government spending.
What are the key characteristics of a fixed exchange rate system in an open economy?
Central bank lacks control over monetary policy, fiscal policy is crucial, interest rates must align with global rates, and fiscal policy is more potent due to no crowding out from rising interest rates.
How does short-run analysis differ from long-run analysis in terms of the price level?
Short-run analysis takes the price level as given both domestically and internationally, contrary to the long run.
Why is fiscal policy relatively more potent under a fixed exchange rate system?
It doesn't face crowding out from rising interest rates.
How is the IS-LM Model used to illustrate shifts in the economy due to policy measures in an open economy?
The IS curve incorporates changes in the exchange rate influenced by interest rate adjustments, resulting in higher output.
What are the economic outcomes of fiscal expansions under fixed exchange rates?
They have more pronounced multipliers, but this effect is diminished by import spending due to the propensity to import.
What are the three critical equations used to analyze an open economy in the short run?
Goods Market Equilibrium, Money Market Equilibrium, and Interest Parity Condition.
Explain the impact of fiscal policy on investment in an open economy with fixed exchange rates.
There is no crowding out of investment due to fixed global interest rates.
Why is fiscal policy less effective under a floating exchange rate system?
Due to potential crowding out of investment and exports.
What are the endogenous variables in a model of a floating exchange rate system?
Output (Y), exchange rate (E), and either money supply (M) or interest rate (I), depending on the policy focus.
How does the central bank's manipulation of interest rates affect the exchange rate in a floating exchange rate system?
It significantly affects the exchange rate and thereby the entire demand spectrum.
Explain how central banks maintain exchange rates under a fixed system.
Central banks maintain exchange rates by buying or selling domestic currency to match the target exchange rate.
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