Econ182_ProbSet1Solns

Econ182_ProbSet1Solns - UNIVERSITY OF CALIFORNIA Berkeley...

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UNIVERSITY OF CALIFORNIA - Berkeley Department of Economics Econ 182 Prof. Kasa International Monetary Economics Spring 2008 PROBLEM SET 1 - Solutions Questions 1-3. Answer True, False, or Uncertain. Briefly explain your answer. No credit without explanation (5 points each). 1. UNCERTAIN. It depends on whether private sector saving offsets public saving (i.e., ‘Ricar- dian Equivalence’). From the National Income Accounting Identity we have S p - I G - T + CA That is, an excess of private sector saving over investment must go into either financing a government deficit or lending abroad (current account surplus). Alternatively, if neither S p nor I responds to changes in the government deficit, then any increases or deceases in the budget deficit get reflected one-for-one in changes in the current account deficit, i.e., they are “twins”. 2. FALSE. Overshooting occurs because the asset market is always in equilibrium (ie., Uncovered Interest Parity holds). For example, suppose the money supply falls (permanently). Because prices are temporarily sticky, the real money supply also falls, and this forces up the interest rate (output is assumed constant). At the same time, the lower money supply leads to an expected future appreciation, since people expect the price level to eventually be lower. Now, if the asset markets are in equilibrium, the higher domestic interest rate must be associated with an expected depreciation of the currency (i..e, an expected capital loss matches the higher
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