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Let us consider an open economy which has removed all barriers to capital mobility. The open economy comprises three agents: households, firms and a government (which includes monetary authorities). We denote GDP by Y, the domestic interest rate by r, the exchange rate (i.e., the pound sterling price of one euro) by e (a rise in e means a depreciation of the pound sterling), and by r* the world interest rate. Prices are fixed and normalized to unity. The economy is described by the following equations:

Let us consider an open economy which has removed all barriers to capital mobility. The open economy comprises three agents: households, firms and a government (which includes monetary authorities). We denote GDP by Y, the domestic interest rate by r, the exchange rate (i.e., the pound sterling price of one euro) by e (a rise in e means a depreciation of the pound sterling), and by r* the world interest rate. Prices are fixed and normalized to unity. The economy is described by the following equations:

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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1 Questions to Be Prepared Let us consider an open economy which has removed all barriers to capital mobility. The open economy comprises three agents: households, firms and a government (which includes monetary authorities). We denote GDP by Y, the domestic interest rate by r, the exchange rate (i.e., the pound sterling price of one euro) by e (a rise in e means a depreciation of the pound sterling), and by r* the world interest rate. Prices are fixed and normalized to unity. The economy is described by the following equations: C C(Y-T), 0<Cy_T < 1, I I (r), Ir <0, G G₁ T = T, NX = NX (e,Y), NXe > 0, NXy < 0, MD L (Y,r), Ly>0, Lr <0, MS = M + H₂ CI = CI (r-r*), CI, > 0, (la) (1b) (1c) (1d) (le) (1f) (1g) (1h) where a bar indicates that the variable is exogenous; C and G are final consumption expenditure by households and the government, respectively, T are lump-sum taxes, I stands for invest- ment (i.e., gross fixed capital formation), NX net exports (i.e., exports, EX(e), less imports, e .IM*(e,Y), expressed in local currency, say pound sterling), MD and MS are money demand and supply; money supply MS = M + H includes an exogenous component, M, and an endoge- nous component H = ARES which is the change in international reserves; in a floating exchange rate regime, H = 0; CI are capital inflows defined as investment less savings; if CI > 0, it means that the country sells more domestic assets than it purchases foreign assets and thus experiences capital inflows; if CI < 0, it means than the country purchases more foreign assets than it sells domestic assets and thus experiences capital outflows. A rise in r makes domestic assets profitable and thus leads to capital inflows. 1. Which condition implies that an exchange rate depreciation produces an increase in net exports? Explain. 1 2. Comment equations (1). 3. Derive the slopes of the IS-, LM-, and BP-schedule in the (Y,r)-space. Develop intuition about their pattern. Note: for simplicity purposes, we assume that net exports is a good approximation of the current account.
Transcribed Image Text:1 Questions to Be Prepared Let us consider an open economy which has removed all barriers to capital mobility. The open economy comprises three agents: households, firms and a government (which includes monetary authorities). We denote GDP by Y, the domestic interest rate by r, the exchange rate (i.e., the pound sterling price of one euro) by e (a rise in e means a depreciation of the pound sterling), and by r* the world interest rate. Prices are fixed and normalized to unity. The economy is described by the following equations: C C(Y-T), 0<Cy_T < 1, I I (r), Ir <0, G G₁ T = T, NX = NX (e,Y), NXe > 0, NXy < 0, MD L (Y,r), Ly>0, Lr <0, MS = M + H₂ CI = CI (r-r*), CI, > 0, (la) (1b) (1c) (1d) (le) (1f) (1g) (1h) where a bar indicates that the variable is exogenous; C and G are final consumption expenditure by households and the government, respectively, T are lump-sum taxes, I stands for invest- ment (i.e., gross fixed capital formation), NX net exports (i.e., exports, EX(e), less imports, e .IM*(e,Y), expressed in local currency, say pound sterling), MD and MS are money demand and supply; money supply MS = M + H includes an exogenous component, M, and an endoge- nous component H = ARES which is the change in international reserves; in a floating exchange rate regime, H = 0; CI are capital inflows defined as investment less savings; if CI > 0, it means that the country sells more domestic assets than it purchases foreign assets and thus experiences capital inflows; if CI < 0, it means than the country purchases more foreign assets than it sells domestic assets and thus experiences capital outflows. A rise in r makes domestic assets profitable and thus leads to capital inflows. 1. Which condition implies that an exchange rate depreciation produces an increase in net exports? Explain. 1 2. Comment equations (1). 3. Derive the slopes of the IS-, LM-, and BP-schedule in the (Y,r)-space. Develop intuition about their pattern. Note: for simplicity purposes, we assume that net exports is a good approximation of the current account.
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