Thus the mundell fleming model explains the aggregate

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Unformatted text preview: that debtors have higher propensities to spend than creditors, so debtors reduce spending by more than creditors raise theirs. The net effect is a reduction in spending, a contractionary shift in the IS curve. - The second concerns the effects of expected deflation. We have assume that I = I(r), and now we say that I = I(i – πe), and demand for money M/P = L(i, Y), thus changes in expected inflation shift the IS curve, when it is drawn with the nominal interest rate on the vertical axis. Suppose that one day everyone expects that the price level will fall in the future, so that πe becomes negative. At any given nominal interest rate, the real interest rate is higher by the amount that πe has dropped. Thus, IS shifts down by this amount, and national income is reduced. Expected deflation reduces investment because firms know they will have to pay back the loan with more valuable dollars, which reduces income, which reduces demand for money, and reduces the nominal interest rate that equilibrates the money market. The nominal interest rate falls by less than expected deflation, so the real interest rate rises. Page 38 of 52 Jessica Gahtan Prof: Mokhles Hossain Macroeconomics ECON2000 Fall 2013 Could it happen again? Since we do not yet fully agree on the causes of the Great Depression, it is impossible to rule out with certainty another depression of this magnitude. However, the mistakes that led to it are unlikely to be repeated. Monetary and fiscal policy blunders have been corrected. Also, institutions such as the system of deposit insurance, central banks, and automatic stabilizes such as income tax causing an automatic reduction in taxes in a recession would help prevent the events of the 1930s from recurring. We also have better knowledge about how the economy works. Chapter 12 The model developed in this chapter is called the Mundell- Fleming model. It is “the dominant policy paradigm for studying open- economy monetary and fiscal policy.” The model makes one important assumption: that the economy being is a small open economy (like Canada) with perfect capital mobility. That is, the economy can borrow or lend as much as it wants in world financial markets, and, as a r...
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This test prep was uploaded on 03/28/2014 for the course ECON 2000 taught by Professor Henriques during the Fall '10 term at York University.

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