Use the Mundell-Fleming model to try to understand the basis for this criticism and show a possible policy that Germany might pursue that could have a beneficial impact on another member country of the euro zone. (Hints: 1. assume that there are two countries, Germany and Spain; 2. both of these countries are in the euro zone and neither can run independent monetary policies (i.e. for each country inside the zone the money supply adjusts automatically to preserve equilibrium); 3. there is perfect capital mobility; 4. prices remain constant in both countries; and 5. assume Spanish exports to Germany will rise if German GDP rises.)
a. Given the hints above, how do the equation(s) of the model (presented in Chapter 7) change for Spain? Describe any new parameter(s) required for the model.
b. Assuming that Germany wants to be helpful to its neighbors, what does the model suggest that Germany should do to address the criticism described above? In a set of graphs, show the impact of your recommendation on the German and Spanish economies. In the new equilibrium, what will be the impacts on German and Spanish output levels, interest rates, and CABs? Explain in a sentence or two.