Consider an open-economy IS-LM model. The domestic economy is small relative to the world economy. Also, assume that domestic and foreign inflation and expected inflation are zero and that the real exchange rate equals the nominal exchange rate. To begin with, suppose the exchange rate is flexible. Use an open economy IS-LM model to explain: A. Explain the effects of a contractionary foreign monetary policy (an increase in i∗) on 1) domestic output, 2) domestic interest rates, 3) exchange rate and 4) net exports. [Assume that foreign output Y∗ is unchanged] B. Following part (A), assume that, when i∗ increases, there is now also a decline in foreign output. How would this change your answers in part (A)? C. Now consider the scenario in part (A) (i.e. i∗ increases but Y∗ remains unchanged). Suppose that the domestic economy wishes to m
Consider an open-economy IS-LM model. The domestic economy is small relative to the world economy. Also, assume that domestic and foreign inflation and expected inflation are zero and that the real exchange rate equals the nominal exchange rate. To begin with, suppose the exchange rate is flexible. Use an open economy IS-LM model to explain:
A. Explain the effects of a contractionary foreign
B. Following part (A), assume that, when i∗ increases, there is now also a decline in foreign output. How would this change your answers in part (A)?
C. Now consider the scenario in part (A) (i.e. i∗ increases but Y∗ remains unchanged). Suppose that the domestic economy wishes to maintain stability in exchange rates, what policies can it implement to ensure stable exchange rates following the contractionary foreign monetary policy (with unchanged foreign output)? Are there challenges associated with ensuring a stable exchange rate? Explain.
D. Now suppose the exchange rate is fixed with E=E¯. Explain how, if at all, a fixed exchange rate changes your answers to part (a). Does the fixed exchange rate protect the domestic economy from foreign monetary policy shocks (i.e. changes in Y∗ and i∗)? Why or why not? Explain.
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
D. Now suppose the exchange rate is fixed with E=E¯. Explain how, if at all, a fixed exchange rate changes your answers to part (a). Does the fixed exchange rate protect the domestic economy from foreign
by Bartleby Expert
