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ECMC61 Midterm Answer Key – Fall 2011 Question 1 (20 points) 1 point will be subtracted for each incorrect entry X Y Z Gross domestic product 6000 5000 4000 Consumption 4200 3000 2000 Investment 900 750 600 Government spending 310 1520 1720 Current account 590 – 270 – 320 National Saving 1490 480 280 Non-reserve portion of financial account – 590 295 295 Official reserve transactions 0 – 125 125 Capital account 0 100 – 100 Question 2 (20 points) (– 2 pts from the whole question for not having 4 decimal points) Part (a) (4 points) Expected exchange rate, E e : (2 pts – 1 pt for showing work & 1 pt for the answer) E e = P/P* = 3/1.5 = 2 Exchange rate, E: (2 pts – 1 pt for showing work & 1 pt for the answer) = E = 1.9619 or, R = = E = 1.9608 Part (b) (4 points) New expected exchange rate: E e = 2 + 0.2 = 2.2 (1 pt) New money demand: L(R, Y) = 0.14Y – 15000R (1 pt) Domestic interest rate, R: (1 pt) = 0.14(45000) – 15000R R = 0.02 Exchange rate: (1 pt) = E = 2.2216 or, R = = E = 2.2222 Part (c) (4 points) Domestic price level, P: (2 pts – 1 pt for showing work & 1 pt for the answer) = 0.14(45000) – 15000(0.05) P = 3.2432 1 ECMC61 Midterm Answer Key – Fall 2011

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Exchange rate, E: (2 pts – 1 pt for showing work & 1 pt for the answer) = E = 2.1581 or, R = = E = 2.1569 Part (d) (8 points) To keep the exchange rate from changing, foreign central bank should conduct pursue a temporary expansionary monetary policy. The level of R* that keeps E at 1.9619: (2 pts) = – 0.0904 Alternatively, The level of R* that keeps E at 1.9608: R = R* = 0.02 – R* = – 0.102 Since R* CANNOT be negative (1 pt) , so the central bank of Foreign CANNOT depreciate FC back to its initial long-run level. (1 pt)
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