RQ_Solution_Ch_19 - ECMC61 Chapter 19 Review Questions...

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ECMC61 – Chapter 19 Review Questions Answer Key Question 1: Problems #10 Suppose there is a one-time (permanent) rise in the foreign price level, P * : Holding all else constant, DC depreciates in real terms when P* , . The real depreciation of DC makes domestic goods becomes relatively cheaper, home’s CA and the DD schedule shifts down and to the right to DD(P *,1 ). Since P * permanently , agents expect DC to appreciate . Indeed, agents expect the exchange rate to fall in proportional to the increase in P*, i.e., E e and the AA schedule downward to AA(E e,1 ) from AA(E e,0 ). Equilibrium is point B: no change in output and DC appreciates to E 1 . At point B, DC appreciates in proportion to the rise in P * . Why? According to APPP, , if P * , then E proportionally. Effect of a rise in P * on domestic money market: An increase in P* has no effect on domestic money market . Why? Given MS and Y are held constant and at point B, Y = Y FE there is no pressure for price to adjust; the real money demand and real money supply remain unchanged. There is no change in R and the domestic money market equilibrium. Effect of a rise in P* on domestic current account: An increase in P* has no effect on domestic CA. Why?
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RQ_Solution_Ch_19 - ECMC61 Chapter 19 Review Questions...

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