solution_ps8

# solution_ps8 - Econ315 International Macroeconomics...

This preview shows pages 1–3. Sign up to view the full content.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Econ315: International Macroeconomics Solution problem set 8 Note: this problem set will not be graded. In the second part of the course problem sets will be graded every other time . STRUCTURE OF THE MODEL: Consider the following small open economy model. The money demand equation is decreasing in the nominal interest rate: M d t P t = ® ¡ ¯i t (1) and money supply follows from Central Bank balance sheet: M s t = FX t + DC t (2) The money market equilibrium implies: FX t + DC t P t = ® ¡ ¯i t (3) Under perfect capital mobility the uncovered interest rate parity equation holds: e e t +1 ¡ e t e t = i t ¡ i ¤ t (4) We assume that there is perfect foresight so that the agents correctly foresee the future path of the nominal exchange rate. We normalize the foreign interest rate to 0. e e t +1 = e t +1 with i ¤ t = 0 ) e t +1 ¡ e t e t = i t In this simple model we also assume that purchasing power parity holds and we normalise the foreign price level to 1. e t P ¤ t P t = 1 with P ¤ t = 1 ) e t = P t a) The domestic credit component of the money supply expands constantly at the rate ¹: DC t = DC t ¡ 1 + ¹ In order to keep the exchange rate ¯xed the central bank needs to maintain the overall money supply constant. If the nominal exchange rate is ¯xed at 1 the level e; we have from (4) that the nominal interest rate is equal to the foreign correspondent and equal to zero. Since purchasing power parity holds, the money market equilibrium (3) implies that...
View Full Document

## This note was uploaded on 10/06/2011 for the course FIN 426 taught by Professor Gregbauer during the Spring '11 term at Rochester.

### Page1 / 4

solution_ps8 - Econ315 International Macroeconomics...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online