Question

1. a. Explain the macroeconomic effects of a monetary expansion in a small country with perfect capital mobility.

b. Explain the macroeconomic effects of a monetary expansion in a small country with zero capital mobility.

Answer 1

Ans ) A small country with perfect capital mobility means a country that does not effect the world interest rate here the investors investment is dependent on the prevailing interest rate in the domestic country as these foreign investors will invest  in the country with high interest rate as compare to the country with low interest rate as the capital is perfectly  mobile.So the foreign investors will invest in those countries that yields higher return and which intern depend upon perfect mobility of capital and World interest rate here it is to be noted that perfect capital mobility implies capital is internationally allowed to flow without restriction.If there is expansionery monetary policy in a country as the economy has more liquidity because of lowering interest rate hence the World interest rate is higher than domestic interest rate the foreign investors will do capital outflow for earning higher return in the other countries.

Ans 2) If the mobility of capital is zero than foreign investors will not be able to take the advantage of higher interest rates in some other countries.As a result there would not be the effect of foreign capital outflow and return on investment will be based on solely on interest rate but there is no perfect mobility of capital hence to attract investment interest rate is to be made high as compared to world interest rate.