Chapter 5 takes this equilibrium as a starting point. We proceed to ask whether and how equilibrium can be influenced by fiscal and monetary policy, and how one country’s equilibrium income may be linked to that of others.
This chapter is designed to sharpen our understanding of the IS-LM-FE or Mundell–Fleming model. We will do so
■ by reconsidering the effects of government expenditures, and of fiscal pol- icy in general, and
■ by taking a first look at monetary policy.
Along the way we will learn to appreciate the important role of the exchange
rate system. As a recurrent theme we will also discuss the role of expectations.