Reference no: EM133200507

Assignment:

Problem

1. Short answer questions:

(a) How might trade barriers affect the short run current exchange rate?

(b) What were the Russian capital controls imposed in Spring 2022, and why did they help support the ruble? Demonstrate on a graph of the Russian asset market. HINT: put the US-ruble exchange rate on the y-axis and Russian denominated assets on the x-axis.

(c) What's the difference between a sterilized and un-sterilized foreign exchange intervention?

2. Suppose a US firm offers a $105 face value bond, whose current price is $100. The current US-Yuan exchange rate is 8 (8 Yuan to buy 1 dollar).

(a) How much Yuan does this bond currently cost?

(b) If you expect the exchange rate to be 8.05 tomorrow, do you expect the Yuan to appreciate or depreciate? What is your expected return?

(c) If you hear that China has been joined the WTO and is preparing to increase exports to the US, would you expect the exchange rate to increase to 8.1 or fall back to 7.9? Why? What would be the expected return then? Remember: This is a dollar denominated bond.

(d) Would your answer in part (c) make you more or less likely to buy this bond?

3. Consider our 3-period monetary policy model from Unit 2 (starting on slide 39). Remember that in the model we have downward nominal wage rigidity (nominal wages can't fall). Let σ = .5 and Υ = 1. Assume the current price level is P₁ = 1 and the firm's price markup is 1.1 (so the nominal wage, W₁ = real wage (W₁/P₁) ≈ .9).

(a) Start with the household's labor supply condition derived on slide 43. Under full employment, what must labor supply be equal to? When Y_t = L_t and c_t = Y_t, what must labor demand be equal to? Find the level of consumption/output consistent with full employment.

(b) Now take the household's first period Euler equation Suppose β₁ = .98. Suppose further than households know that P₂ = 1.1 and c₂ = .8. Solve for the nominal interest rate, i₁ that results in full employment.

(c) Now suppose households become nervous and their discount rate, β₁ rises to 1.3. What is the i₁ associated with full employment now? Is this feasible?

(d) Has anything happened (yet) to the domestic price level? Given your answer, would we expect any changes in the current exchange rate between this country and its neighbor? HINT: Think about how the relative price level affects the future exchange rate.

(e) Can the central bank use any other tools to boost demand? What will that do to prices tomorrow P₂? What would the effect be on the future exchange rate? The current exchange rate?