Internal and external balance mean in international finance

 

1. (10 points) What do the terms internal and external balance mean in international finance?
2. (12 points) In the Mundell-Fleming model of the open-economy, what are the conditions for equilibrium in (a) the product market; (b) the money market; and (c) the foreign exchange market.
3. (6 points) What are two factors that will shift the IS curve to the right?
4. (6 points) What are two factors that will shift the LM curve to the left?
5. (6 points) What are two factors that will shift the FE curve to the right?
6. (15 points) A country has a fixed exchange rate and capital is very mobile. Because it is experiencing high unemployment, the central bank increases the money supply. Using symbols and words and diagrams, explain what will happen to (a) internal balance; (b) external balance; (c) the country’s exchange rate. How must the central bank respond if it wishes to maintain the fixed exchange rate?

7. (15 points) In the case above, the government tries to reduce unemployment by increasing government spending (expansionary fiscal policy). Explain, using symbols, words and diagrams, what will happen to internal and external balance. What will happen to the exchange rate?

8. (15 points) If, in the case above, capital is not very mobile, how will fiscal policy impact the economy? The exchange rate? Again, use symbols, words and diagrams.

9. (15 points) What is the J-curve effect in international finance? What are three possible causes of the J-curve effect?

 

Sample Solution

The Mundell–Fleming model, also known as the IS-LM-BoP model (or IS-LM-BP model), is an economic model first set forth (independently) by Robert Mundell and Marcus Fleming. The model is an extension of the IS-LM model. Whereas the traditional IS-LM model deals with economy under autarky (or a closed economy), the Mundell–Fleming model describes a small open economy. The Mundell–Fleming model portrays the short-run relationship between an economy’s nominal exchange rate, interest rate, and output (in contrast to the closed-economy IS-LM model, which focuses only on the relationship between the interest rate and output). Under the Mundell–Fleming framework of a small economy facing perfect capital mobility, the domestic interest rate is fixed and equilibrium in both markets can only be maintained by adjustments of the nominal exchange rate or the money supply (by international funds flows).

Although Catherine Earnshaw is raised with Heathcliff and develops feelings of affection for him, she still cannot deny Heathcliff’s true, savage nature. When Isabella declares her love for Heathcliff, Catherine warns her about his malicious and unkind character. Catherine says “Tell her what Heathcliff is: an unreclaimed creature, without refinement, without cultivation; an arid wilderness of furze and whinstone… Pray, don’t imagine that he conceals depths of benevolence and affection beneath a stern exterior.. he’s a fierce, pitiless, wolfish man.” From Catherines statement the reader understands that Catherine believes Heathcliff to be an evil man and she tries to stop Isabella from pursuing him so that she does not get hurt by his actions.

 

 

It is clear that Heathcliff is a vengeful man. He seeks vengeance on Hindley Earnshaw for Hindley’s treatment of him when he inherited Wuthering Heights. Hindley is cruel towards Heathcliff because his father had always preferred Heathcliff to Hindley. After Hindley inherits Wuthering Heights he makes Heathcliff work on the land like a slave, causing Heathcliff to seek revenge on him. Although Hindley dies, this is not satisfactory enough for Heathcliff and he plans to treat Hindley’s son just as Hindley treated Heathcliff. Heathcliff says to the boy “Now, my bonny lad, you are mine! And we’ll see if one tree won’t grow as crooked as another, with the same wind to twist it!” The fact that Heathcliff would intend to treat an innocent child so harshly speaks volumes about his evil nature and shows that he would mistreat Hindley’s son, just to get vengeance.

Heathcliff is an extremely selfish character, only concerned with his own needs and desires. This is displayed after the death of Heathcliff’s one true love. When he is told that Catherine has died in child birth, he is only interested in his own grief. He proclaims “…Catherine Earnshaw, may you not rest as long as I am living…” Heathcliff would rather Catherine come back from the grave to haunt him as a ghost than allow her to rest peacefully. He would deny her knowing the peace of death just to satisfy his needs. Heathcliff also shows no concern for the wellbeing of Catherine’s new born daughter or her husband because he does not even mention them while he is grieving catherine, highlighting his selfish attitude.

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