Question 3Consider a small-open endowment economy with free capital mobility, a single traded good per pe-riod, and a government that levies lump-sum taxes to finance government purchases. Assume that thereis no physical capital and hence no investment. Assume that the economy exists for an infinite numberof periods. The four building blocks that compose our monetary economy are:Mt= L(C, i.)(3)PeP = EP(4)1+ = (1+r")-(5)EtMt- Mt-1B – BDEF(6)Etwhere Mt is the money supply in period t; P, is the domestic price level in period t; L(C, u) is the moneydemand function; C is consumption; i is the nominal interest rate in the domestic economy; Et is thenominal exchange rate expressed as units of domestic.currency per one unit of foreign currency; P is theforeign price level in period t; r* is the real interest rate in a foreign country; E is expected nominalexchange rate in period t + 1; B is international bond holdings held by the government; DEF, is asecondary fiscal deficit.A) Explain under which conditions the uncovered interest rate parity condition could be expressed as1+ i = (1+r*)B) Suppose, under a floating exchange rate regime, the central bank expands money supply at a con-stant positive rate u each period: M = (1+ µ)M-1, and the exchange rate depreciates at rateH.i) What would happen to the nominal exchange rate, interest rate and price level in the econ-omy?ii) Does government have any seignorage revenue? How would it look like?

The provided economic system is based on a small-open endowment economy with three key features:…

Consider a small-open endowment economy with free capital mobility, a single traded good per pe- riod, and a government that levies lump-sum taxes to finance government purchases. Assume that there is no physical capital and hence no investment. Assume that the economy exists for an infinite number of periods. The four building blocks that compose our monetary economy are: M₁ Pt = L(C, it) = P₁ = E₁Pt 1+ i = (1+r) = E₁+1 Et Mt - Mt-1 B-B-1= (6) Et where M, is the money supply in period t; P, is the domestic price level in period t; L(C, it) is the money demand function; C is consumption; it is the nominal interest rate in the domestic economy; Et is the nominal exchange rate expressed as units of domestic currency per one unit of foreign currency; Pt is the foreign price level in period t; r* is the real interest rate in a foreign country; E, is expected nominal - DEF (3) (4) (5) -

Consider a small-open endowment economy with free capital mobility, a single traded good per pe- riod, and a government that levies lump-sum taxes to finance government purchases. Assume that there is no physical capital and hence no investment. Assume that the economy exists for an infinite number of periods. The four building blocks that compose our monetary economy are: M₁ Pt = L(C, it) = P₁ = E₁Pt 1+ i = (1+r) = E₁+1 Et Mt - Mt-1 B-B-1= (6) Et where M, is the money supply in period t; P, is the domestic price level in period t; L(C, it) is the money demand function; C is consumption; it is the nominal interest rate in the domestic economy; Et is the nominal exchange rate expressed as units of domestic currency per one unit of foreign currency; Pt is the foreign price level in period t; r* is the real interest rate in a foreign country; E, is expected nominal - DEF (3) (4) (5) -

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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