a) What is meant by a "“credible target zone"? Develop Krugman's (1991) model and then explain how a credible target zone has a stabilizing effect on the exchange rates. Explain the intuition behind the smooth pasting condition 1 b) Use the Balassa-Samuelson model to explain why the purchasing power parity may not hold in the presence of nontraded goods. How is the relative productivity of tradeable goods of nations related to the real exchange rate? Carefully explain the intuitions using the Balassa-Samuelson model.

a) What is meant by a "“credible target zone"? Develop Krugman's (1991) model and then explain how a credible target zone has a stabilizing effect on the exchange rates. Explain the intuition behind the smooth pasting condition 1 b) Use the Balassa-Samuelson model to explain why the purchasing power parity may not hold in the presence of nontraded goods. How is the relative productivity of tradeable goods of nations related to the real exchange rate? Carefully explain the intuitions using the Balassa-Samuelson model.

Principles of Economics 2e

2nd Edition

ISBN:9781947172364

Author:Steven A. Greenlaw; David Shapiro

Publisher:Steven A. Greenlaw; David Shapiro

Chapter23: The International Trade And Capital Flows

Section: Chapter Questions

Problem 46P: Imagine that the economy of Germany finds itself in the following situation: the government budget...

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