Consider the following open economy model of the exchange rate and price (in logarithms) e 0.8y+4+0.1(sp) p = 0.1(e- y) md p+0.5y - 0.5r md = ms = 105 r = r" + $e §º = $ y 20, 10 The first equation measures aggregate demand (consumption depends on income, and net exports depend on the real exchange rate). The second equation is the Phillips curve; the third equation is the money demand function; the fourth equation states that money demand must equal money supply; the fifth equation is the UIP condition; and the sixth equation is the perfect foresight assumption for expectation formation. The economy is at full employment of y 20, so any adjustment must be via the exchange rate or prices. Foreign interest rates are fixed at 10. (i) (ii) Show in steady state the equilibrium exchange rate and price level is 100. Show we can reduce the model to the following two equations p=0.01p+0.01s $ = 2p-200 (iii) Use the model set up in the spreadsheet (iv) to show what happens if the initial position is (s, p) = (100, 110). Draw a graph the price level against the exchange for the first 200 periods. Explain what is happening in the goods and foreign exchange markets. Use the model set up in the spreadsheet to show what happens if the money supply is increased to 110 and the exchange rate market reacts to this news by jumping to a values = 173.25 in period 1. Hint. Verify the dynamic equation for prices remains unaltered but the dynamic equation for the exchange rate becomes s = 2p - 210. Explain what is happening in the goods and foreign exchange markets (you should mention overshooting andwhy the foreign exchange market jumped to 173.25 and where is finishes).
Consider the following open economy model of the exchange rate and price (in logarithms) e 0.8y+4+0.1(sp) p = 0.1(e- y) md p+0.5y - 0.5r md = ms = 105 r = r" + $e §º = $ y 20, 10 The first equation measures aggregate demand (consumption depends on income, and net exports depend on the real exchange rate). The second equation is the Phillips curve; the third equation is the money demand function; the fourth equation states that money demand must equal money supply; the fifth equation is the UIP condition; and the sixth equation is the perfect foresight assumption for expectation formation. The economy is at full employment of y 20, so any adjustment must be via the exchange rate or prices. Foreign interest rates are fixed at 10. (i) (ii) Show in steady state the equilibrium exchange rate and price level is 100. Show we can reduce the model to the following two equations p=0.01p+0.01s $ = 2p-200 (iii) Use the model set up in the spreadsheet (iv) to show what happens if the initial position is (s, p) = (100, 110). Draw a graph the price level against the exchange for the first 200 periods. Explain what is happening in the goods and foreign exchange markets. Use the model set up in the spreadsheet to show what happens if the money supply is increased to 110 and the exchange rate market reacts to this news by jumping to a values = 173.25 in period 1. Hint. Verify the dynamic equation for prices remains unaltered but the dynamic equation for the exchange rate becomes s = 2p - 210. Explain what is happening in the goods and foreign exchange markets (you should mention overshooting andwhy the foreign exchange market jumped to 173.25 and where is finishes).
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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just subparts iii and iv please. spreadsheet attached.. (t goes up to 200) (s(t) and p(t) always remain at 100)
Transcribed Image Text:t
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HARREGAGGAN≈±22222222
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p=0.01p + 0.01s
s 2p 200
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s(t)
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p(t)
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dt =
Price level, p(t)
120.00
100.00
80.00
60.00
40.00
20.00
0.00
0
0.10
20
Parameters
40
-0.01
0.01
Dornbusch model of the exchange rate
0
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-200
60
exchange rate, s(t)
80
100
120
Transcribed Image Text:Consider the following open economy model of the exchange rate and price (in logarithms)
e = 0.8y + 4 + 0.1(sp)
(ii)
(iii)
p = 0.1(e - y)
mªp + 0.5y 0.5r
md = m³ = 105
y = 20, r= 10
The first equation measures aggregate demand (consumption depends on income, and net
exports depend on the real exchange rate). The second equation is the Phillips curve; the third
equation is the money demand function; the fourth equation states that money demand must
equal money supply; the fifth equation is the UIP condition; and the sixth equation is the
perfect foresight assumption for expectation formation. The economy is at full employment
of y= 20, so any adjustment must be via the exchange rate or prices. Foreign interest rates are
fixed at 10.
(i)
(iv)
r = r² + ŚⓇ
Ś = Ś
Show in steady state the equilibrium exchange rate and price level is 100.
Show we can reduce the model to the following two equations
p=0.01p+ 0.01s
s = 2p - 200
Use the model set up in the spreadsheet
to show what happens if the
initial position is (s, p) = (100, 110). Draw a graph the price level against the
exchange for the first 200 periods. Explain what is happening in the goods and
foreign exchange markets.
Use the model set up in the spreadsheet
to show what happens if the
money supply is increased to 110 and the exchange rate market reacts to this news
by jumping to a value s = 173.25 in period 1. Hint. Verify the dynamic equation
for prices remains unaltered but the dynamic equation for the exchange rate
becomes
$ = 2p - 210.
Explain what is happening in the goods and foreign exchange markets (you should
mention overshooting andwhy the foreign exchange market jumped to 173.25 and
where is finishes).
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