After the Global Financial Crisis, the demand for Poland’s and Latvia’s exports declined as aresult of a contraction in foreign output Y* in their trading partners, mainly the rest of Europe.In addition, Poland and Latvia faced negative shocks to consumption and investment demand asconsumers and investors cut back their expenditures in the face of uncertainty and tighter creditdue to financial sector problems. The policy responses differed in each country, illustrating thecontrasts between fixed and floating regimes. Because the Poles had a floating exchange rate,they were able to pursue strong monetary expansion and let the currency depreciate. They alsomaintained their plans for government spending in order to combat the decline in demand.Because the Letts were pegging to the euro, they could not use monetary policy at all, and theyhad to pursue aggressive austerity and slash government spending in order to satisfy thedemands of a European Union and International Monetary Fund assistance program. Use theIS/LM/FX framework to make predictions about the consequences of these policy choices.
After the Global Financial Crisis, the
result of a contraction in foreign output Y* in their trading partners, mainly the rest of Europe.
In addition, Poland and Latvia faced negative shocks to consumption and investment demand as
consumers and investors cut back their expenditures in the face of uncertainty and tighter credit
due to financial sector problems. The policy responses differed in each country, illustrating the
contrasts between fixed and floating regimes. Because the Poles had a floating exchange rate,
they were able to pursue strong monetary expansion and let the currency
maintained their plans for government spending in order to combat the decline in demand.
Because the Letts were pegging to the euro, they could not use
had to pursue aggressive austerity and slash government spending in order to satisfy the
demands of a European Union and International Monetary Fund assistance program. Use the
IS/LM/FX framework to make predictions about the consequences of these policy choices.
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