Macroeconomics

12-3

The Small Open Economy Under 

Fixed Exchange Rates

We now turn to the second type of exchange-rate system: fixed exchange

rates.

Under a fixed exchange rate, the central bank announces a value for the

exchange rate and stands ready to buy and sell the domestic currency to keep

the exchange rate at its announced level. In the 1950s and 1960s, most of the

world’s major economies, including that of the United States, operated within

C H A P T E R   1 2

The Open Economy Revisited: The Mundell-Fleming Model and the Exchange-Rate Regime

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F I G U R E

1 2 - 6

Exchange rate, e

Exchange rate, e

Net exports, NX

Income, output, Y

NX

2

NX

1

IS*

2

LM*

IS*

1

3. ... increasing

the exchange

rate ...

4. ... and

leaving income

the same.

(a) The Shift in the Net-Exports Schedule

1. A trade restriction

shifts the NX curve

outward, ...

(b) The Change in the Economy