Question 1

Answer all parts.

Assuming perfect asset substitutability and perfect capital mobility, use the Mundell-Fleming

model to describe the process of adjustment to the short-run equilibrium for a small open

economy under fixed and flexible exchange rates following:

(a) A contractionary monetary policy.

[20 marks]

(b) A contractionary fiscal policy.

[20 marks]

(c) Explain how the choice of an exchange rate system affects the efficacy of

macroeconomic policies.

10 marks

(Total 50 marks)