Exercise - MACROECONOMICS- For M.A. in Development Economics

Exercise 3.4

a. The second row shows the price of EURO expressed in US dollars. If the EURO appreciates,

the price of EURO increases. The month with the largest appreciation was April.

b. The price of one YUAN in US dollars in May

CNY/EUR	GBP/EUR	CNY/GBP
Jan	8.8178	0.8458	10.4254
Feb	8.9734	0.8463	10.6031
March	9.1902	0.8665	10.60612
April	9.4316	0.8829	10.68252
May	9.3198	0.8779	10.61602
June	9.3161	0.8874	10.4982

Exercise 3.4

c. which months did the YUAN appreciate against the POUND

-May

-June

Exercise 3.9

a. Ms↑ è shift LM curve downward.

(LM curve: combinations of Y and i for which the demand for money equals the money

supply)

- A higher money supply must be met by a higher money demand è LM curve

shifting

downward indicates that we need higher income or lower interest rates (or some

combination of these effects) to induce people to increase money demand

Exercise 3.9

b. G↓ è shift IS curve to the left,

meaning that at any level of income, the interest rate is now lower.

Exercise 3.9

c. Y world ↓ è export demand ↓ Therefore shifts the IS curve to the left.

Exercise 3.9

d. An increase in the foreign price level increases the real exchange rate leads to

a depreciation of the domestic currency.

The associated increase in export demand shifts the IS curve to the right.

Exercise 4.3

-Domestic interest rate is higher than the interest rate abroad

-Domestic capital is in high demand, i.e. there is a capital account surplus.

a. Flexible exchange rates

-Demand surplus for the domestic currency è domestic currency appreciates è

decline in net exports and, thereby, to a reduction in aggregate demand.The IS

curve shifts left until the IS, LM and FE curves all intersect in one point, i.e. until

an equilibrium in all three markets is reached. In the process, Y falls.

b. Fixed exchange rates

-The domestic central bank has to increase the money supply to keep exchange

rate fixed when domestic capital is in high demand.

-The expansion of the money supply shifts the LM curve down until the IS, LM and

FE curves all intersect in one point, i.e. until an equilibrium in all three markets is

reached. In the process, Y increases.

Fixed exchange rates + Perfect international capital mobility

i W ↑ è shifts FE curve up è i D falls temporarily below i W è domestic assets lose

their international competitiveness è Investors wish to sell their domestic assets

è increase the supply of domestic currency è domestic currency depreciates (1)

Central bank è purchase domestic currency to absorb the increased supply in

the foreign exchange market è reducing Ms è shifts LM curve up (2) New equilibrium,

the domestic interest rate equals the new world interest rate and output is below its

former level.

Exercise 5.3

The increase in the foreign interest rate might be caused by expansionary fiscal

or contractionary monetary policy in a large foreign country. Since there are externalities

to fiscal and monetary

policy actions (especially if the country where such policies are conducted is large),

policy-making may give rise to political disputes between countries. Expansionary

fiscal policy in a large country may, e.g. cause serious recessions in other (smaller) countries.

Exercise 5.4

Fixed exchange rates + Perfect capital mobility

Devaluation of domestic currency è directly shifts the IS curve to the right (The

increase in exports and the decrease in imports make net exports increase) è i

D increases temporarily (1) (It rises above the level of the world interest rate.) è

an inflow of capital è domestic currency appreciates

è Under fixed exchange rates, the central bank must expand the money supply

of shifts the LM curve down (2)

In the new equilibrium, income has increased while the interest rate is back at its

old equilibrium level

Exercise 5.5

Positive demand shock è shifts IS curve to the right è temporarily domestic interest rate↑ (1)

(Without policy intervention, the domestic currency would have to appreciate in order to

balance demand and supply in the foreign exchange market, and the IS curve

would shift back to its old position.)

If the exchange rate has to be kept at its initial level, expansionary monetary

policy could be used to balance demand and supply in the foreign exchange

market. Expansionary monetary policy would shift the LM curve down, leading

to a higher level of output at an unchanged exchange rate. (2)