Question

9. A problem using the general monetary model Suppose we use the general model, in which real money demand is L(i)rand we assume that both relative PPP (RPPP) and uncovered interest parity (UIP) hold. Consider two countries, Australia (A) and New Zealand (NZ). Imagine in a particular year that Australia had slower real income growth (2%) and NZ had higher real income growth (5%). Suppose the central bank of A permitted the nominal money supply to grow by 4% per year and the central bank of NZ permitted its monetary growth rate to be 12% per year let bank deposits in Australia pay a 5% annual interest rate. Finally, define the exchange rate as Ezswhich is the price of an Australian dollar in terms of New Zealand dollars. (For these calculations consider NZ to be the home" country and A to be the "foreign" country.) AS a. Calculate the inflation rates in A and NZ. b. Using the Fisher effect, calculate the interest rate paid on NZ deposits. c. Calculate the expected real interest rate (nominal interest rate minus inflation rate) in both countries, using the inflation rates from part a as the expected inflation rates NZ Briefly explain why these are the same. d. Using the information so far, compute the expected percentage change in the spot exchange rate Is this a depreciation or apprcciation of the NZS? Using the UIP condition, cxplain why the exchange rate must move in that direction. Suppose the central bank of NZ lovers the money growth rate from 12% per year to 8% per year and this also reduces the NZ inflation rate in the same proportion (that is, by 4 percentage points). Ifthe nominal interest rate in A remains the same, what must happen to the interest rate paid in NZ? New iNz e.