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1. Use the Mundell-Fleming model to predict what would happen to aggregate income, the exchange rate, and the trade balance undera fixed exchange rates and perfect capital mobility in response to each of the following: (a)A reduction in the income tax - Essay Example

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Figure 1 above shows the initial equilibrium in the Mundel-Fleming model under a pegged exchange rate regime and perfect capital mobility (translates to the horizontal BOP line). In the following we consider the effects of certain exogenous changes on the equilibrium.
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1. Use the Mundell-Fleming model to predict what would happen to aggregate income, the exchange rate, and the trade balance undera fixed exchange rates and perfect capital mobility in response to each of the following: (a)A reduction in the income tax

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1. Use the Mundell-Fleming model to predict what would happen to aggregate income, the exchange rate, and the trade balance undera fixed exchange rates and perfect capital mobility in response to each of the following: (a)A reduction in the income tax

Download file to see previous pages... 3. This buying of foreign currency in turn leads to an increase in the International Reserves of the economy and therefore, the monetary base of the economy expands which in turn leads to a rise in the money supply. Consequentially, the LM curve also shifts outwards.
2. The domestic currency will tend to depreciate. To prevent this and retain the exchange rate at its pegged value, the central bank will have to sell of foreign currency thereby reducing the monetary ...Download file to see next pagesRead More
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