Consider the following open economy model of the exchange rate and price (in logarithms) e 0.8y+4+0.1(sp) p = 0.1(e- y) md p+0.5y - 0.5r md = ms = 105 r = r" + $e §º = $ y 20, 10 The first equation measures aggregate demand (consumption depends on income, and net exports depend on the real exchange rate). The second equation is the Phillips curve; the third equation is the money demand function; the fourth equation states that money demand must equal money supply; the fifth equation is the UIP condition; and the sixth equation is the perfect foresight assumption for expectation formation. The economy is at full employment of y 20, so any adjustment must be via the exchange rate or prices. Foreign interest rates are fixed at 10. (i) (ii) Show in steady state the equilibrium exchange rate and price level is 100. Show we can reduce the model to the following two equations p=0.01p+0.01s $ = 2p-200 (iii) Use the model set up in the spreadsheet (iv) to show what happens if the initial position is (s, p) = (100, 110). Draw a graph the price level against the exchange for the first 200 periods. Explain what is happening in the goods and foreign exchange markets. Use the model set up in the spreadsheet to show what happens if the money supply is increased to 110 and the exchange rate market reacts to this news by jumping to a values = 173.25 in period 1. Hint. Verify the dynamic equation for prices remains unaltered but the dynamic equation for the exchange rate becomes s = 2p - 210. Explain what is happening in the goods and foreign exchange markets (you should mention overshooting andwhy the foreign exchange market jumped to 173.25 and where is finishes).
Consider the following open economy model of the exchange rate and price (in logarithms) e 0.8y+4+0.1(sp) p = 0.1(e- y) md p+0.5y - 0.5r md = ms = 105 r = r" + $e §º = $ y 20, 10 The first equation measures aggregate demand (consumption depends on income, and net exports depend on the real exchange rate). The second equation is the Phillips curve; the third equation is the money demand function; the fourth equation states that money demand must equal money supply; the fifth equation is the UIP condition; and the sixth equation is the perfect foresight assumption for expectation formation. The economy is at full employment of y 20, so any adjustment must be via the exchange rate or prices. Foreign interest rates are fixed at 10. (i) (ii) Show in steady state the equilibrium exchange rate and price level is 100. Show we can reduce the model to the following two equations p=0.01p+0.01s $ = 2p-200 (iii) Use the model set up in the spreadsheet (iv) to show what happens if the initial position is (s, p) = (100, 110). Draw a graph the price level against the exchange for the first 200 periods. Explain what is happening in the goods and foreign exchange markets. Use the model set up in the spreadsheet to show what happens if the money supply is increased to 110 and the exchange rate market reacts to this news by jumping to a values = 173.25 in period 1. Hint. Verify the dynamic equation for prices remains unaltered but the dynamic equation for the exchange rate becomes s = 2p - 210. Explain what is happening in the goods and foreign exchange markets (you should mention overshooting andwhy the foreign exchange market jumped to 173.25 and where is finishes).
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
Related questions
Question
just subparts iii and iv please. spreadsheet attached.. (t goes up to 200) (s(t) and p(t) always remain at 100)
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 4 steps with 7 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.Recommended textbooks for you
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (MindTap Course List)
Economics
ISBN:
9781305585126
Author:
N. Gregory Mankiw
Publisher:
Cengage Learning
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Managerial Economics & Business Strategy (Mcgraw-…
Economics
ISBN:
9781259290619
Author:
Michael Baye, Jeff Prince
Publisher:
McGraw-Hill Education