In the Mundell–Fleming model with floating exchange rates, an increase in a country's risk premium will cause income to _____ and the exchange rate to _____.fall; risefall; fallrise; riserise; fall
Question
In the Mundell–Fleming model with floating exchange rates, an increase in a country's risk premium will cause income to _____ and the exchange rate to _____.fall; risefall; fallrise; riserise; fall
Solution
In the Mundell-Fleming model with floating exchange rates, an increase in a country's risk premium will cause income to fall and the exchange rate to rise.
Here's why:
-
An increase in a country's risk premium means that investors see the country as a riskier place to invest. This could be due to a variety of factors, such as political instability, economic uncertainty, or poor fiscal management.
-
As a result, foreign investors will demand a higher return for investing in the country, which effectively increases the cost of capital for businesses in the country.
-
This higher cost of capital will reduce investment, leading to a decrease in aggregate demand and thus a fall in income.
-
At the same time, the increase in the risk premium will cause a capital outflow as investors move their money to safer countries. This increases the supply of the country's currency on the foreign exchange market.
-
With more of the country's currency available on the market, the value of the currency will fall, leading to a rise in the exchange rate (since the exchange rate is the price of the country's currency in terms of another currency).
Similar Questions
In the Mundell–Fleming model with a fixed exchange rate, an attempt by the central bank to lower the money supply cause the exchange rate to rise, giving arbitrageurs the incentive to ______ the central bank, which causes the money supply to ______.A.sell domestic currency to;decreaseB.sell domestic currency to;increaseC.buy domestic currency from;decreaseD.buy domestic currency from;increase
In the Mundell-Fleming model，Suppose the risk premium (θ) rises due to an increased risk associated with investing or lending to the domestic country. which answer of the effects of a change in the risk premium is right. （Assume that whatever happens in a small open economy does not affect world financial markets.）A.IS* curve shifts to leftLM* curve shifts to rightB.IS* curve shifts to leftLM* curve shifts to leftC.IS* curve shifts to rightLM* curve shifts to leftD.IS* curve shifts to rightLM* curve shifts to right
Mundell-Fleming model suggests that a decrease in the money supply will lead to what? A. Higher interest rates and a stronger currency B. Lower interest rates and a weaker currency C. Higher interest rates and a weaker currency D. Lower interest rates and a stronger currency
In the Mundell-Fleming Model for a small open economy with perfect capital mobility and a fixed exchange rate regime, if there is an increase in government spending, what immediate effect is expected on the country's foreign exchange reserves?A.A. The foreign exchange reserves will increase.B.The foreign exchange reserves will decrease.C.The foreign exchange reserves will remain unchanged.D.The impact on the foreign exchange reserves is unpredictable.
In the Mundell-Fleming model, assuming a fixed exchange rate regime, what happens when the country's central bank attempts to reduce the money supply to control inflation?A.A. Exchange rate rises, money supply increases. B.B. Exchange rate rises, money supply decreases. .C.C. Exchange rate falls, money supply increases. D.D. Exchange rate falls, money supply decreases.
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.