Question from Past Macroeconomics Qualifying ExamEdit
Spring, 2004 - Question four- at George Mason University
Evaluate the implications for monetary and fiscal policy in a large open economy under conditions (1) of fixed and (2) of flexible exchange rates, paying particular attention to the following models:
- a. The Neoclassical Synthesis
- b. Rational Expectations
- c. Does this analysis offer any insight into whether or not large open economies should prefer fixed or flexible exchange rate systems?
- a. Neoclassicals accept the policy tool of adjusting the exchange rate (for montetary expansion). Fiscal policy is not regarded as having a negative effect, maybe even it augments the expansionary regime. Additionally pegging would cause problems of the same type which any nominal peg would cause. This would prevent the normal adjustment of the price mechanism (do pegs make sence for the goods market)? -- Basically neoclassical synthesis allows for some of the nominal rigidities necessary to have fiscal and monetary effects.
- b. Rational expectations seems to have a limited role for the use of either money or government to influence the economy. The changes should be predictable (based on the incentives of the officials) and the economy should be able to adjust quickly enough to cancel the effects.
- c. The world most likely exists in some combination of the assumptions. It is more compelling to believe that supprise movements in the aggregates would take longer to adjust to than the standard- macro policies of fiscal and monetary expansions. If these motives are not fully predicted, or if there is some cost in getting this information it seems that there would be a responce to these neoclassical assumptions.
- Mundell, Robert “The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability” IMF staff papers. 1962.