Question

Uni ule government allows the exchange rate to float. a. Lump-sum taxes increase. b. Foreign income increases. c. Investors expect an appreciation of the home currency. d. The money supply decreases. 2. For each of the following scenarios, assume the economy experiences an exogenous decrease in investment demand. For each case, illustrate the IS-LM-FX diagram and state the effect of the shock (increase, decrease, no change, or ambiguous) on the following variables: Y, i, E, C, I, TB. Here, we assume the policy makers' objective is to keep output fixed at its initial value. a. Monetary policy response under a floating exchange rate regime. b. Fiscal policy response under a floating exchange rate regime. c. Monetary policy response under a fixed exchange rate regime. d. Fiscal policy response under a fixed exchange rate regime. 3. This question uses a numerical example to understand the connections between the goods, money, and foreign exchange (FX) markets. Use the information below to answer the following questions. FX Market Money Market M= 3200 E' = 4 Goods Market C = 200+ 0.25(Y) 1 =150 +0.25Y - 1000 i G= 250 i* = 10% I = 2Y - 80001 P= 2

Answer 1

Que undex Fixed Exchange Rate Monetauy Poli Policy(Expansion) interest LM IS 9101e -> Output y This figus Rat ply Imp lies Balance of Payment is in equilib91um, eve of interest rates i in our ecomomy is equ al to those in absH©ad i= i, IS - LM are at equi li 6 941um at p0int E implies y* leuel of out put y* is fuu employment output level Consid es the mometasiy expans ion stasits and ue ShouoS IS -LM S chedules as well ar tAe BP= O e 1s Ruge Bui at e conomy moues to the point capital outfiow and pies sure fo r exchan qe Hat e to depsieciat e. NOLO, tke centsial bank inteavies o Pp fooergn money exchange So;te supply of domestic LM Shifts backcoard up to the lett This psiocess contnue do meshc mon S1eceiving and n decline and money unhl tee nitial equilibłumis dretoied -> C Expans'ion) .Policy Fis cal oiA tae money Supply initialty unch anged a fiscal ex pansion moves tAe IS curve up and to the to ingiease both the intenest giate and tfe level tend ng The hig hes inteswst Ha+e seis a Of tee outpul capital mlow that oo uld lead ke ex chang e ate to appse ciate.
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interest g1 a ie ^ TS' LM IS LM BP - o output excharae sate, to expand the money supply, thus incie asıng futhe Equilib 9n um is 1estosie d when the money To maintaun the tA e centHal bank has income Supply Aas Incieased e nough to do1ve the Interest iate back to i ts asi qinal level, i - if Txpansionasuy Policy Monetay-Same sarme same y TG Same Same Same FiScal SameT Same unde Flexible Exchange R ate Fis cal Expansionasiy Po l intesies 9 04e ^ TS GP-o output A tax cut or an incaLease in goueinment s penan would eac to an expansion tAdemaAd iALAeGan in tåe demand. This boing increase in money demand and Sises interest rate. The giesulhng copi tal inftows

mmecuaiay The capi ad inflows causes the eehange appsieciate Mate put ptessSute m tAe e Curoieney to The appsie cuahon of cuurcnency, means, tRa mposit psices fal and domestic qoocls and mox 6ecomes mosie expensi ve . Demand shift awa fom Netatuely domeshc goods, and met expoit decure. ke appsieciahon implies the Is schedule shuts back fa Fos fexiDie ates, by eeAst contsNast, a fiscal expansion coes mot change equrlibnum output : but Shifts HA e Cerepesa Compo siton of domes tic demand to ward foSegn demand Expars ionay Poliy Moneiasy mlerest ate -> JS BP- O TS output A monelaSiy expansimo shifis tAe Lm sche cule to LM', AE poin! , the good and money masik et cle a1, bUH OLs Inten est iate is belous the looHld level. Ihor capital wil tend to flow oul, the balance of payměnts goes into dejicit , and tre exchange ai e deprieciates. Te elepseciaies depiecia thon means that we becoms moe Compeh hve. Nel eKpoiis 9Ise and the TS cuurve will Shyt out and to the Qught,

JS The poocess contnues until Ke ackes cuVe at the oo1 Id teuei and E Tnerest iates ane er level of t tAe de p sieuah on ha led to a IncHea asy poicy ncome Mone net exposls Expansionasy E C T B nemetoy Same Same Ascal Same Same same Same Same same