ECS3706
Assignment 2 Semester 1 2025
Unique Number:
Due Date: April 2025
QUESTION 1
(a) Appropriate Macroeconomic Policies under Flexible and Fixed Exchange Rate
Systems
Under the Mundell-Fleming framework with perfect capital mobility, Sub-Saharan African
countries—assuming they are small open economies—will experience capital inflows and
outflows in response to interest rate differentials. These capital flows significantly influence
the effectiveness of monetary and fiscal policies, depending on whether the exchange rate
is flexible or fixed.
1. Flexible Exchange Rate Regime: Use Monetary Policy
Under a flexible exchange rate system, expansionary monetary policy is the most effective
tool. When the central bank increases the money supply, the LM curve shifts rightward,
reducing interest rates. With perfect capital mobility, lower domestic interest rates lead to
capital outflows and currency depreciation.
DISCLAIMER & TERMS OF USE
Educational Aid: These study notes are intended to be used as educational resources and should not be seen as a
replacement for individual research, critical analysis, or professional consultation. Students are encouraged to perform
their own research and seek advice from their instructors or academic advisors for specific assignment guidelines.
Personal Responsibility: While every effort has been made to ensure the accuracy and reliability of the information in
these study notes, the seller does not guarantee the completeness or correctness of all content. The buyer is
responsible for verifying the accuracy of the information and exercising their own judgment when applying it to their
assignments.
Academic Integrity: It is essential for students to maintain academic integrity and follow their institution's policies
regarding plagiarism, citation, and referencing. These study notes should be used as learning tools and sources of
inspiration. Any direct reproduction of the content without proper citation and acknowledgment may be considered
academic misconduct.
Limited Liability: The seller shall not be liable for any direct or indirect damages, losses, or consequences arising from
the use of these notes. This includes, but is not limited to, poor academic performance, penalties, or any other negative
consequences resulting from the application or misuse of the information provided.
, For additional support +27 81 278 3372
QUESTION 1
(a) Appropriate Macroeconomic Policies under Flexible and Fixed Exchange
Rate Systems
Under the Mundell-Fleming framework with perfect capital mobility, Sub-Saharan
African countries—assuming they are small open economies—will experience capital
inflows and outflows in response to interest rate differentials. These capital flows
significantly influence the effectiveness of monetary and fiscal policies, depending on
whether the exchange rate is flexible or fixed.
1. Flexible Exchange Rate Regime: Use Monetary Policy
Under a flexible exchange rate system, expansionary monetary policy is the most
effective tool. When the central bank increases the money supply, the LM curve
shifts rightward, reducing interest rates. With perfect capital mobility, lower domestic
interest rates lead to capital outflows and currency depreciation.
Depreciation boosts net exports by making exports cheaper and imports more
expensive, which increases aggregate demand and output. The IS curve shifts
rightward due to higher net exports, leading to a new equilibrium with higher output
and stable interest rates. The current account also improves due to increased
exports. Thus, monetary policy is highly effective in addressing both unemployment
and current account balance in this regime.
Conclusion: Under a flexible exchange rate, Sub-Saharan African countries should
rely on monetary policy to stabilise the economy and correct external imbalances.
2. Fixed Exchange Rate Regime: Use Fiscal Policy
Under a fixed exchange rate regime, monetary policy becomes ineffective. Any
attempt to expand the money supply leads to a balance of payments deficit (LM
shifts right), causing downward pressure on the currency. To maintain the fixed
exchange rate, the central bank must intervene by buying domestic currency, which
reduces the money supply and shifts the LM curve back—nullifying the effect of the
initial expansionary policy.
In contrast, expansionary fiscal policy (e.g., increased government spending or tax
cuts) shifts the IS curve to the right, increasing output and interest rates. Higher
Assignment 2 Semester 1 2025
Unique Number:
Due Date: April 2025
QUESTION 1
(a) Appropriate Macroeconomic Policies under Flexible and Fixed Exchange Rate
Systems
Under the Mundell-Fleming framework with perfect capital mobility, Sub-Saharan African
countries—assuming they are small open economies—will experience capital inflows and
outflows in response to interest rate differentials. These capital flows significantly influence
the effectiveness of monetary and fiscal policies, depending on whether the exchange rate
is flexible or fixed.
1. Flexible Exchange Rate Regime: Use Monetary Policy
Under a flexible exchange rate system, expansionary monetary policy is the most effective
tool. When the central bank increases the money supply, the LM curve shifts rightward,
reducing interest rates. With perfect capital mobility, lower domestic interest rates lead to
capital outflows and currency depreciation.
DISCLAIMER & TERMS OF USE
Educational Aid: These study notes are intended to be used as educational resources and should not be seen as a
replacement for individual research, critical analysis, or professional consultation. Students are encouraged to perform
their own research and seek advice from their instructors or academic advisors for specific assignment guidelines.
Personal Responsibility: While every effort has been made to ensure the accuracy and reliability of the information in
these study notes, the seller does not guarantee the completeness or correctness of all content. The buyer is
responsible for verifying the accuracy of the information and exercising their own judgment when applying it to their
assignments.
Academic Integrity: It is essential for students to maintain academic integrity and follow their institution's policies
regarding plagiarism, citation, and referencing. These study notes should be used as learning tools and sources of
inspiration. Any direct reproduction of the content without proper citation and acknowledgment may be considered
academic misconduct.
Limited Liability: The seller shall not be liable for any direct or indirect damages, losses, or consequences arising from
the use of these notes. This includes, but is not limited to, poor academic performance, penalties, or any other negative
consequences resulting from the application or misuse of the information provided.
, For additional support +27 81 278 3372
QUESTION 1
(a) Appropriate Macroeconomic Policies under Flexible and Fixed Exchange
Rate Systems
Under the Mundell-Fleming framework with perfect capital mobility, Sub-Saharan
African countries—assuming they are small open economies—will experience capital
inflows and outflows in response to interest rate differentials. These capital flows
significantly influence the effectiveness of monetary and fiscal policies, depending on
whether the exchange rate is flexible or fixed.
1. Flexible Exchange Rate Regime: Use Monetary Policy
Under a flexible exchange rate system, expansionary monetary policy is the most
effective tool. When the central bank increases the money supply, the LM curve
shifts rightward, reducing interest rates. With perfect capital mobility, lower domestic
interest rates lead to capital outflows and currency depreciation.
Depreciation boosts net exports by making exports cheaper and imports more
expensive, which increases aggregate demand and output. The IS curve shifts
rightward due to higher net exports, leading to a new equilibrium with higher output
and stable interest rates. The current account also improves due to increased
exports. Thus, monetary policy is highly effective in addressing both unemployment
and current account balance in this regime.
Conclusion: Under a flexible exchange rate, Sub-Saharan African countries should
rely on monetary policy to stabilise the economy and correct external imbalances.
2. Fixed Exchange Rate Regime: Use Fiscal Policy
Under a fixed exchange rate regime, monetary policy becomes ineffective. Any
attempt to expand the money supply leads to a balance of payments deficit (LM
shifts right), causing downward pressure on the currency. To maintain the fixed
exchange rate, the central bank must intervene by buying domestic currency, which
reduces the money supply and shifts the LM curve back—nullifying the effect of the
initial expansionary policy.
In contrast, expansionary fiscal policy (e.g., increased government spending or tax
cuts) shifts the IS curve to the right, increasing output and interest rates. Higher
