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Consider the following version of the Mundell-Fleming model with perfect capital

ID: 1194180 • Letter: C

Question

Consider the following version of the Mundell-Fleming model with perfect capital mobility: IS* curve: Y = C(Y - T) + I(r) + G + NX(e, Y). LM* curve: M^5/P = L^d(r.Y). The price level P is fixed. Compare the output effect of a fall in the foreign interest rate under fixed and floating exchange rates. In each case, list which variables you will treat as endogenous. State the assumptions you rely on. What options do the authorities have if they want to avoid that the fall in the foreign interest rate has an output effect? Distinguish between the case with fixed and floating exchange rates.

Explanation / Answer

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