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Consider an open economy operating under flexible exchange rates. Assuming that both the domestic and foreign...

Consider an open economy operating under flexible exchange rates. Assuming that both the domestic and foreign prices are constant, the economy's short-run behavior can be described by the following IS, LM and interest-parity equations:

Y = C(Y-T)+I(Y,i)+G+NX(Y,Y*,E)
i = i
E = ((1+i)/(1+i*)Ee

The notation is standard except for the policy interest rate which is denoted by i (Moodle doesn't have the over-bar). The expected exchange rate Ee, foreign output Y* and the foreign interest rate i* are taken to be exogenous. Suppose that initially NX=0.
Analyze the effects of an increase in the expected exchange rate (Ee) on the exchange rate (E), net exports (NX), and the domestic output (Y), consumption (C) and investment (I). Briefly describe the economic intuition behind these effects.

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Rahul Sunny answered 2 years ago
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