22 PS1

Consider an open economy like Australia with free capital mobility and a floating exchange rate. Using the Mundell-Fleming IS-LM model: (a) Explain how a fiscal policy expansion can stimulate the economy and how it impacts on the balance of payments. (2.5 marks) (b) Explain how the adoption of a restrictive monetary policy by the United States Federal Reserve Bank will impact the Australian economy and its balance of payments. (2.5 marks) Now consider an open economy with free capital mobility and a fixed exchange rate. Using the Mundell-Fleming IS-LM model: (c) Explain the effect on the economy of an expansionary monetary policy. (2.5 marks) (d) Explain the effect on the economy of an increase in the foreign rate of interest of the dominant global economy. (2.5 marks)