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Unformatted text preview: its interest rate, and they must match movements in the
foreign interest rate risking unwanted effects on its own activity.
Although the country retains control of fiscal policy, one policy
instrument is not enough. A country that wants to decrease its budget
deficit cannot, under fixed exchange rates, use monetary policy to
offset the contractionary effect of its fiscal policy on output. KEY TERMS
demand for domestic goods domestic demand for goods
J-curve Mundell-Fleming model
European Monetary System (EMS)
twin deficits 17 REFRESH (TRUE, FALSE, OR UNCERTAIN)
1. The national income identity implies that budget deficits cause
false 2. A fiscal expansion tends to increase net export.
false 3. Fiscal policy has a greater effect on output in an economy with
fixed exchange rates than in an economy with flexible
monetary accomodation 4. Other things being equal, the interest parity condition implies
that the domestic currency will appreciate in response to an
increase in the expected exchange rate.
true 18 REFRESH
5. If financial investors expect the dollar to depreciate against
the yen over the coming year, one-year interest rates will be
higher in the US than in Japan.
true 6. UIP If the Japanese interest rate is equal to zero, foreigners will not
want to hold Japanese bonds.
uncertain 7. Under fixed exchange rates, the money stock must be
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This note was uploaded on 03/05/2014 for the course ECON 2123 taught by Professor Yanyu during the Fall '13 term at HKUST.
- Fall '13