What is the percentage increase in the price level

Assignment Help Macroeconomics

Reference no: EM131479995

Question: The government of the Republic of Andea is currently pegging the Andean peso to the dollar at E = 1 peso per dollar. Assume the following:

In year 1 the money supply M is 2,250 pesos, reserves R are 1,250 pesos, and domestic credit B is 1,000 pesos. To finance spending, B is growing at 50% per year. Inflation is currently zero, prices are flexible, PPP holds at all times, and initially, P = 1. Assume also that the foreign price level is P* = 1, so PPP holds. The government will float the peso if and only if it runs out of reserves. The U.S. nominal interest rate is 5%. Real output is fixed at Y = 2,250 at all times. Real money balances are M/P = 2,250 = L(i) Y, and L is initially equal to 1.

a. Assume that Andean investors are myopic and do not foresee the reserves running out. Compute domestic credit in years 1, 2, 3, 4, and 5. At each date, also compute reserves, money supply, and the growth rate of money supply since the previous period (in percent).

b. Continue to assume myopia. When do reserves run out? Call this time T. Assume inflation is constant after time T. What will that new inflation rate be? What will the rate of depreciation be? What will the new domestic interest rate be? (Hint: Use PPP and the Fisher effect.)

c. Continue to assume myopia. Suppose that at time T, when the home interest rate i increases, then L(i) drops from 1 to 2/3. Recall that Y remains fixed. What is M/P before time T? What will be the new level of M/P after time T, once reserves have run out and inflation has started?

d. Continue to assume myopia. At time T, what is the price level going to be right before reserves run out? Right after? What is the percentage increase in the price level? In the exchange rate? [Hint: Use the answer to part (c) and PPP.]

e. Suppose investors know the rate at which domestic credit is growing. Is the path described above consistent with rational behavior? What would rational investors want to do instead?

f. Given the data presented in the question so far, when do you think a speculative attack would occur? At what level of reserves will such an attack occur? Explain your answer.

Reference no: EM131479995

Questions Cloud

What is the firm profit-maximizing quantity : Suppose it has a short run total cost function given by TC= 12000 +0.002q^2. If the market price is 12, what is the firm's profit-maximizing quantity?

Write reply - idea of a kill switch : This idea of a kill switch seems like it is taking us further in that direction by offering more control of the population.

How do you define integrity : How do franchises differ from other businesses? How do you define integrity?

What factors bind marriages and families together : "What factors bind marriages and families together? How have these factors changed, and how has the divorce rate been affected?"

What is the percentage increase in the price level : The government of the Republic of Andea is currently pegging the Andean peso to the dollar at E = 1 peso per dollar. Assume the following: In year 1 the money.

Quantity of money demanded : Contrast that with the factors that would cause an increase in (b) the demand for money. Graph required.

Why is home interest rate higher under noncredible peg : A peg is not credible when investors fear depreciation in the future, despite official announcements. Why is the home interest rate always higher.

Transparency corruption index : Given that corruption at Siemens came as a surprise to German society, how credible is the Transparency Corruption Index that is based on the perception.

Demonstrate communication skills in the business environment : Purpose: The goal of this project is to show that you can demonstrate communication skills in the business and professional environment.

User Account

All Pages