PS-5 - Spring 2016-Intt 212 Problem Set 5 Please try to...

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Spring 2016-Intt 212 - Problem Set 5 Please try to solve the problems on your own and check your answers with the following ones: End of Chapter 17 problems: 2, 4, 5, 7, 8, 11, 12, 13, 17 2. A tariff is a tax on the consumption of imports. The demand for domestic goods, and thus the level of aggregate demand, will be higher for any level of the exchange rate. This is depicted in Figure 17(6)-1 (below) as a rightward shift in the output market schedule from DD to D D . If the tariff is temporary, this is the only effect, and output will rise even though the exchange rate appreciates as the economy moves from points 0 to 1. If the tariff is permanent, however, the long-run expected exchange rate appreciates, so the asset market schedule shifts to A A . The appreciation of the currency is sharper in this case. If output is initially at full employment, then there is no change in output due to a permanent tariff. Figure 17(6)-1 4. A permanent fall in private aggregate demand causes the DD curve to shift inward and to the left and, because the expected future exchange rate depreciates, the AA curve shifts outward and to the right. These two shifts result in no effect on output, however, for the same reason that a permanent fiscal expansion has no effect on output. The net effect is a depreciation in the nominal exchange rate and, because prices will not change, a corresponding real exchange rate depreciation. A macroeconomic policy response to this event would not be warranted.
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5. Figure 17(6)-2 (below) can be used to show that any permanent fiscal expansion worsens the current account. In this diagram, the schedule XX represents combinations of the exchange rate and income for which the current account is in balance. Points above and to the left of XX represent current account surplus, and points below and to the right represent current account deficit. A permanent fiscal expansion shifts the DD curve to D D and, because of the effect on the long-run exchange rate, the AA curve shifts to A A . The equilibrium point moves from 0, where
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