Reference no: EM132655352

SCENARIO: An open economy IS-LM-UIP model (LM curve is sloping upwards as money supply is held fixed not the interest rate)

• IS:  Y = C(Y-T)+I(Y,i)+G+NX(Y,Y*,E)
• LM:  M/Y = Y L(i)
• UIP:     i = i* - [ (E^e - E) / E ]

(E^e is expected future nominal exchange rate and E is the current nominal exchange rate)

Details: Model can be used to reflect either a floating exchange rate regime or a fixed exchange rate regime. 

ASSUME THAT- the expected future inflation rate is zero (which is why i rather than r appears in the IS expression); the Marshall-Lerner condition holds; and P* and P are exogenously fixed and unchanging (which is why E rather than appears in the IS expression).

TASK ONE: For an economy operating under (1) a floating exchange rate regime

Use the -above- model to show diagrammatically and explain the impact that enhanced expectations of a nominal depreciation/devaluation of New Zealand's exchange rate would have on current i, Y, E and business fixed investment expenditure, I, for an economy under a floating exchange rate regime

TASK TWO: For an economy operating under (2) a fixed exchange rate regime

Use the -above- model to show diagrammatically and explain the impact that enhanced expectations of a nominal depreciation/devaluation of New Zealand's exchange rate would have on current i, Y, E and business fixed investment expenditure, I, for an economy under a fixed exchange rate regime

Comment on the potential difficulties that a government would have in defending the exchange rate.