Suppose that at the initial equilibrium we know that the price level in the Eurozone is P = 90.91, the dollar-euro expected exchange rate is E² = 1.1, and that the interest rate in the Eurozone is 3%. $/ € For the US variables take the same value as the ones specified in the beginning of the problem. Assume now that the Federal Reserve unexpectedly and permanently increases the nominal money supply from M³ = 100 to M³ = 105. Assume that the European Central Bank remains passive, making no changes to its monetary policy. Based on this information answer the following questions: 1. Find the new short-run equilibrium (interest rate, exchange rate, real money balances). Note that the shock is permanent, so expectations of the exchange rate should change. 2 2. Find the long-run equilibrium (interest rate, exchange rate, prices, real money balances). Is the exchange rate overshooting in the short run? Why? 3. Plot the dynamics of the variables of interest with respect to time. Denote T the period where the permanent shock is introduced.

Suppose that at the initial equilibrium we know that the price level in the Eurozone is P = 90.91, the dollar-euro expected exchange rate is E² = 1.1, and that the interest rate in the Eurozone is 3%. $/ € For the US variables take the same value as the ones specified in the beginning of the problem. Assume now that the Federal Reserve unexpectedly and permanently increases the nominal money supply from M³ = 100 to M³ = 105. Assume that the European Central Bank remains passive, making no changes to its monetary policy. Based on this information answer the following questions: 1. Find the new short-run equilibrium (interest rate, exchange rate, real money balances). Note that the shock is permanent, so expectations of the exchange rate should change. 2 2. Find the long-run equilibrium (interest rate, exchange rate, prices, real money balances). Is the exchange rate overshooting in the short run? Why? 3. Plot the dynamics of the variables of interest with respect to time. Denote T the period where the permanent shock is introduced.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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