Perfect Capital Mobility

Perfect Capital Mobility - Perfect Capital Mobility Perfect...

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Perfect Capital Mobility Perfect capital mobility means that money is free to move between countries in search of the highest interest rate. So, the interest rate all over the world is fixed at r w . monetary policy An increase in the money supply pushes the domestic interest rate below r w . This causes an outflow of money and the money supply shrinks. A contractionary monetary policy has the opposite effect. So, the LM curve is horizontal at r w and monetary policy has no effect on the LM curve. Monetary policy is ineffective under fixed exchange rates and perfect capital mobility. fiscal policy
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A rise in government spending causes the interest rate to rise. With r above r w , money flows into the economy from abroad. The inflow causes the money supply to rise until r falls back to r w . Fiscal policy is effective under fixed exchange rates and perfect capital mobility. Shocks to the Economy 1. domestic monetary shock - e.g. increase in money demand 2. domestic spending shock - flexible rates are procyclical
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Perfect Capital Mobility - Perfect Capital Mobility Perfect...

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