a) Assuming perfect capital mobility and flexible exchange rates, explain the impact on the Irish economy of a decrease in interest rates in the U.S. In your answer, clearly indicate the effect on income, rate of interest, balance of payments.

Mundell – Fleming model and theory of optimum common currencies

a) Assuming perfect capital mobility and flexible exchange rates, explain the impact on the Irish economy of a decrease in interest rates in the U.S. In your answer, clearly indicate the effect on income, rate of interest, balance of payments. (Show your answer with the help of an IS-LM-BP diagram and explain the mechanisms. Consider Ireland a small open economy with flexible exchange rates. (20 marks)

b) Are Monetary and Fiscal policies effective in the case of question (a)? Explain with graphs. (20 marks)

c) Discuss the notion of unholy trinity. (10 marks)

1) IS-LM-BP model and Fiscal policy in common currency areas

a) Briefly describe how the Mundell – Fleming model can help us explain the 1997 Asian crisis. Use graphs with IS-LM-BP for your answer. (15 marks)

b) Discuss how a shift in consumer preferences away from Irish products towards German products affects the output of the two countries. Assume a flexible exchange rate regime. Your discussion should be brief and use graphs (AD- AS). (20 marks)

c) Explain how a free-rider problem arises in a currency union when a government raises the national debt in high levels. (15 marks)

2) Write a short note on each of the following by using graphs when needed (all sub-questions worth 8.33 marks each):

a) PPP implications and limitations

b) Capital flights in the case of Mexico in 1994

c) EU as a currency union

d) Keynesian theory of consumption and criticism

e) Life-cycle theory of consumption and criticism

f) Time inconsistency problem of the Monetary policy