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Suppose we were in a situation where the interest elasticity of investment is low, and money demand is very interest elastic. Explain the effect on the income of monetary and fiscal policy action. Which of the two policies is more effective?
ii. The Mundell-Fleming model takes the world interest rate r* as an exogenous variable. Let's consider what happens when this variable changes.
a. What might cause the world interest rate to rise?
b. In the Mundell-Fleming model with a floating exchange rate, what happens to aggregate income, the exchange rate, and the trade balance when the world interest rate rises?
c. In the Mundell-Fleming model with a fixed exchange rate, what happens to aggregate income, the exchange rate, and the trade balance when the world interest rate rises?
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