3. Explain the relationship between real exchange rates and output in a model of short run...

3. Explain the relationship between real exchange rates and output in a model of short run response to policy shocks. Why czn’t we answer this question about the long run relationship for an economy near full employment? You should graph relative demand and supply to make this happen.

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Expert Solution

The relationship between real exchange rates and output in a model of short run response to policy shocks.

In the short run, when home real interest rate is equal to the world interest, the goods market equilibrium is established.

Aggregate Demand shocks: A shift in autonomous consumption or a change in the world interest rate leads to a shift of the AD- Curve. Changes in the world trade also shift the AD-Curve, but they shift BT curve as well.

Under both fixed and flexibe exchange rates, output and employment are lower, high price competitiveness, low real wages.

If there is no policy intervention, then the economy will adjust to short- run equiibrium.

In the long run, the prices will rise and SAS curve will shift leftwards and the economy wil operate at full employment but at the higher price from before.

Rahul Sunny answered 1 year ago

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