A. When taxes are raised in the Mundell-Fleming model with floating exchange rates, aggregate income will decrease due to the decrease in disposable income for households and businesses. As a result of this decrease in income, domestic consumption and investment will likely decrease, leading to a decrease in aggregate demand. This decrease in demand may put downward pressure on prices, leading to a depreciation of the exchange rate. Additionally, with lower demand for imports due to the decrease in disposable income, the trade balance may improve as exports become relatively cheaper.
B. When government expenditure increases in the Mundell-Fleming model with floating exchange rates, aggregate income will likely increase due to the increase in government spending. This increase in government spending will lead to an increase in aggregate demand, which may put upward pressure on prices. As a result, the exchange rate may appreciate as foreign investors are attracted to the higher interest rates. Additionally, with higher aggregate demand, imports may increase, leading to a deterioration in the trade balance.
C. When the central bank increases money supply in the Mundell-Fleming model with floating exchange rates, aggregate income will likely increase due to the increase in spending power for households and businesses. This increase in money supply will lead to lower interest rates, which may stimulate investment and consumption. The increase in aggregate demand may put upward pressure on prices, leading to a depreciation of the exchange rate. Additionally, with higher aggregate demand, imports may increase, leading to a deterioration in the trade balance.
1. In the Mundell–Fleming model with floating exchange rates, explain what happens to
aggregate income, the exchange rate, and the trade balance when
A. Taxes are raised.
B. Government expenditure increases
C. Central bank increased money supply�
1 answer