Exercise-08-solution

ExerciseEight-Solution1:itisaboutDornbuschModel.Considertheeffectsofa1percentincreaseinthemoneysupply,inDornbusch’sversionofthemonetarymodelofexchangeratedetermination(i.e.,withstickygoodsprices).1)Intheshortrun,whatwouldhappenifforeignexchangetradersquotedtotheircustomersanexchangerateequaltothelevelofitsnewlong-runequilibriumvalue?2)Whatmustactuallyhappentotheexchangerateintheshortruntocleartheforeignexchangemarket?Why?3)Whathappenstotheexchangerateoverthefollowingmonthsoryears?Why?4)Whathappenstotheexchangerateinthelongrun?Why?Suggestedanswer:1)2)3)4)2.answer:e)3.(Option,youcouldtryifyouareinterested)ItisabouttheMonetaryPolicyintheMundell-Flemingmodel.Assumethatthemoneydemandrelationship,goodsdemandrelationship,andbalanceofpaymentsareexpressedbythefollowingfunctionalform.LMcurve:M=Y−λi(Note:WehavenormalizedthepricelevelasP=1.)IScurve:()AbiXEYsmBPcurve:()(*)BPXEmYKAkii1)Forthispart,assumethattheexchangerateisfixed.a.SolvetheLMandISequationssimultaneously.b.ExpressincomeYasafunctionofM,AandX.c.Whatisthe“moneymultiplier,”i.e.,thechangeinrealincome∆Ythatresultsfromagivenchangeintherealmoneysupply∆M?Isitgreaterorlessthan1?(WeareholdingAconstantinthisexperiment.AlsoXbecausetheexchangerateisstillfixed,fornow.)2)Nowassumetheexchangeratefloats,andsothebalanceofpaymentsmustclear.a.UsetheBPequationtoexpressiasafunctionoftheothervariables.b.Inthelimitingcaseofperfectcapitalmobility(κ→∞),howisidetermined?c.UsetheLMcurveandyouranswerto(b)toexpressYasafunctionoftherealmoneysupply,M.d.Nowforthiscaseoffloatingexchangerates,whatisthe“moneymultiplier,”i.e.,thechangeinrealincome∆Ythatresultsfromagivenchangeintherealmoneysupply∆M?Isitlargerorsmallerthantheeffectin1)c?Why?