Answer to Question #283724 in Macroeconomics for ABEX

Question

25. Consider two small open economies A and B which opted to adopt a floating exchange rate regime, and a fixed exchange rate regime, respectively. While Country A wants to exercise fiscal policy, Country B wants to exercise monetary policy.

(a) What are the possible reasons for Country A to adhere to exercising fiscal policy instead of monetary policy?

(b) According to the Mendel-Fleming model and the monetary approach to the balance of payment, what should be the position of Country A on the policy of liberalizing its (foreign) capital account, i.e. capital mobility? explain the reason.

(c) What should be the position of Country B on the policy of liberalizing its (foreign) capital account, i.e. capital mobility? explain the reason.

Answer 1

(a) The possible reason for Country A to adhere to exercising fiscal policy instead of monetary policy is that the monetary policy may be inefficient as a result of floating exchange rate regime.

(b) The Mundell–Fleming model has been used to argue that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy.

(c) A capital account liberalization is a decision by a country's government to move from a closed capital account regime, where capital may not move freely in and out of the country, to an open capital account system in which capital can enter and leave at will.