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Unformatted text preview: P roblem Set # 11 Solutions Chapter 12 #8 a. California is in a currency union (also known as a monetary union) with its major trading partners (the other American states). Moreover, this is a much more durable and serious union than e.g., EMU, since it’s a currency union that coincides with a political union (unlike e.g., EMU, which involves many countries which could, in principle, secede from the currency union). b. Only fiscal policy will be effective. California is a small open economy, and the question assumes that it can print dollars. Since California's dollar is fixed one for one with a dollar from the rest of the United States, we use the IS-LM Model that applies to an open economy with fixed exchange rates and perfect capital mobility. In this model, monetary policy is ineffective. If you aren't sure why monetary policy is ineffective in this case, consider the following example: if the California government decided to increase the money supply by printing dollars and buying bonds back from Californians,...
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This note was uploaded on 10/25/2010 for the course MBA GloEco taught by Professor N.m. during the Spring '10 term at Institute of Business Administration.
- Spring '10