A small open economy is presently experiencing a budget deficit and a higher level of inflation than desired by policy makers. These policy makers are seeking recommendations on what policy or policies would be most appropriate to both help mitigate (reduce) inflation and not result in a substantial increase in the budget deficit.

a) Suppose the country has a flexible exchange rate. In this case what policy or policies would you recommend to achieve both of these goals. Explain how/why this would do so.

b) Suppose the country has a fixed exchange rate. In this case what policy or policies would you recommend to achieve both of these goals. Explain how/why this would do so

c) Explain what role, if any, the “smallness” of this economy plays in these two cases

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a Flexible Exchange Rate To mitigate inflation and avoid a substantial increase in the budget defici... View the full answer