• In a fixed exchange rate system, a fall in the demand for a country’s exports would cause the

supply of foreign exchange schedule to shift to the left. At the fixed exchange rate, a balance
of payments deficit would arise. The CB has to sell FX to maintain the fixed exchange rate .

• With a flexible exchange rate system, again the supply of foreign exchange schedule would
shift to the left, creating an excess demand for foreign exchange at the initial exchange rate.
The exchange rate would rise to clear the foreign exchange market. There would be no
balance of payments deficit.
• V=Marginal propensity to import
• I=i0-i1*r
• Y=income
• 5.4-exam question!
• Chpater7-exam.
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• WEEK 3
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• LM-Money demand
• IS=investment
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• Exam-10 ch8 answers
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• Exam-The Phillips Curve in the sort and long run, pg 218

I
• The tax cut will have a larger effect on income in the case of perfect capital mobility in a
fixed exchange rate system.

• Rise in r attracts capital inflow

• The money supply rises because of central bank intervention and the domestic interest rate
is brought back into equality with the foreign interest rate.

• The increase in the money supply reinforces the expansionary effect of the cut in taxes.

• In a system of fixed exchange rates with perfect capital mobility, the expansionary fiscal
policy (a cut in taxes) is highly effective because there is not a rise in the domestic interest
rate and, therefore, an absence of crowding out.

• Some effect but less with imperfect capital mobility; effect depends on the slope of BP vs.
LM
• Imperfect capital mobility