Reference no: EM131160826
Fixed exchange rates and foreign macroeconomic policy
Consider a fixed exchange rate system, in which a group of countries (called follower countries) peg their currencies to the currency of one country (called the leader country). Since the currency of the leader country is not fixed against the currencies of countries outside the fixed exchange rate system, the leader country can conduct monetary policy as it wishes. For this problem, consider the domestic country to be a follower country and the foreign country to be the leader country.
a. Redo the analysis of Problem 4(a).
b. Redo the analysis of Problem 4(b).
c. Using your answers to parts (a) and (b) and Problem 4(c), how does a foreign monetary expansion (by the leader country) affect domestic output? How does a foreign fiscal expansion (by the leader country) affect domestic output? (You may assume that the effect of Y * on domestic output is small.) How do your answers differ from those in 4(d)?
Problem 4
Flexible exchange rates and foreign macroeconomic policy
Consider an open economy with flexible exchange rates. Let UIP stand for the uncovered interest parity condition.
a. In an IS-LM-UIP diagram, show the effect of an increase in foreign output, Y *, on domestic output, Y. Explain in words.
b. In an IS-LM-UIP diagram, show the effect of an increase in the foreign interest rate, i*, on domestic output, Y. Explain in words.
c. Given the discussion of the effects of fiscal policy in this chapter, what effect is a foreign fiscal expansion likely to have on foreign output, Y *, and on the foreign interest rate, i *? Given the discussion of the effects of monetary policy in this chapter, what effect is a foreign monetary expansion likely to have on Y * and i *?
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