European countries that want to adopt the euro must go through a “probationary” period. During this...

European countries that want to adopt the euro must go through a “probationary” period. During this time, they have to maintain the foreign exchange value of their domestic currency against the euro; set an upper limit on government budget deficits of no more than 3% of GDP; and tie their long-term interest rates to those of the Eurozone by allowing unregulated capital flows with the Eurozone members. Use the IS/LM/BP model to show how these constraints affect their ability to respond to a negative shock in foreign income, such that which occurred in 2008 during the global financial crisis. (Hint: what does the BP curve look like?)

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Rahul Sunny answered 2 years ago

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