PS_4 - METU Department of Economics Econ 202 Macroeconomic...

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1/3 METU Department of Economics Econ 202 Macroeconomic Theory Spring 2010 Problem Set 4 (Chapters 18 – 19 – 20) Q.1 Suppose that the exchange rate is fixed at 10 TL per dollar even though the current exchange rate implied by the market mechanism is 15 TL per dollar. Annual demand for and supply of TL are given as: ܦ = 100 + 5ܧ and ܵ = 400 − 15ܧ where E is the exchange rate defined as TL per $. a) Do the signs make sense? Explain. Do these functions back up the market exchange rate of 15TL per dollar? b) (No numbers required) Suppose investors owning a lot of bonds denominated in TL suddenly start paying attention and decide to sell out into dollars. What would this do to the currency? How can domestic authorities move the interest rate to convince investors to stay a little longer? What effects would this have on the economy? Q.2 Consider the following situation. A country is running a large trade deficit, and the policy maker wants to reduce it while not affecting aggregate output. The exchange rate is flexible. You may assume that the Marshall-Lerner condition is satisfied, that there is no J-curve effect, that the domestic and international prices are fixed and equal and that the country allows capital to flow in or out without restraint. a) Describe a mix of fiscal and monetary policies which would do the job. b) Which components of aggregate demand are different between the old equilibrium and the new equilibrium (i.e., before and after the policies are enacted)? And in what way? c) Suppose the exchange rate is fixed and devaluation is not an option (the point of a fixed exchange rate is precisely that - it should be fixed, and not subject to the whims and fancies of the policy maker). Assume everything else remains as stated in the beginning of the question. Could the policy maker achieve his objective? Why or why not?
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PS_4 - METU Department of Economics Econ 202 Macroeconomic...

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