Question

Problem 2 (4 points) a) Show graphically using the Mundell-Fleming model the of an introduction of export promotion tools (that improve net exports exogenously, irrespective of the exchange rate). Assume that a country has a fixed exchange rate and perfect capital mobility. (2 p) b) Will the introduction of export promotion policy tools improve net exports (current account balance) in equilibrium, as argued by many politicians? Provide an appropriate graph and explain. (2 p)

Answer 1

a)

Fiscal policy or export promotion measures are successful in affecting the aggregate output level in economy if economy follows the fixed exchange rate system.

Following is diagram:

LM LM1 e1 e IS1 IS X Y1 - d.

In above diagram, IS curve shift to right IS1 and exchange rate rises to new level. In order to keep exchange rate, fixed, government would buy foreign exchange from market and it would release money supply, So LM curv will shift to right thereby pushing up output level,

So fiscal policy is successful in increasing output level.

b)

Trade policies to improve Net export does not cause any positive impacts. Following is diagram:

NX(E)2 NX (ε ) , NX NX,

In above diagram: Increase in net export does not affect and S-I, so there will not be affect on NX1.