QUESTION B4 Assume the domestic price level, P, inflationary expectations, πe, and the expected nominal exchange rate,...

QUESTION B4

Assume the domestic price level, P, inflationary expectations, π^e, and the expected nominal exchange rate, E^e, are fixed in the short run; also assume that the Marshall-Lerner conditions hold.

Show diagrammatically and explain the impact, in the short run that a significant fall in international interest rates, i*, would have on the domestic interest rate, i, on the nominal exchange rate, E, on real GDP, Y, and on real private consumer expenditure, C (which is dependent on movements in both household disposable income and i), for an open economy that is operating:

(In answering this question, utilize the open economy IS-LM-UIP model and diagrams developed in the ECON 202 Course.)

(a) A floating exchange rate regime

(b) A fixed exchange rate regime

(In answering this question, utilize the open economy IS-LM-UIP model and diagrams developed in the ECON 202 Course.)

(c) Now suppose this small open economy suffers a recession and needs to achieve a real depreciation for the economy to recover. Explain how this is achieved over the medium term: (i) under a floating exchange rate and (ii) a fixed exchange rate.

Expert Solution

Rahul Sunny answered 2 years ago

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