Question

3.

a. What are the advantages and disadvantages of the fixed exchange rate?

b. Within the Mudell-Fleming model assuming perfect capital mobility, analyze the policy actions of an increase in government expenditure for the flexible exchange rate.

Answer 1

A)

Advantages of fixed exchange rate:

• Avoid Currency Fluctuations
• Stability encourages investment
• Keep inflation Low
• Joining a fixed exchange rate may cause inflationary expectations to be lower

Disadvantages of fixed exchange rate:

• Conflict with other objectives
• Less Flexibility
• Join at the Wrong Rate
• Current Account Imbalances

B) Increase in government expenditure is a part of Expansionary fiscal policy.