Econ 101b International Financial Crises Problem Set

Econ 101b International Financial Crises Problem Set: Algebra

Clean Version

(1) Start with our consensus flexible-price business cycle model, in "differences" form:

Add the exchange rate equation:

and suppose that the government increases purchases, and that that increase in purchases makes foreign exchange speculators scared about the long-run value of the currency and causes a depreciation--an increase in speculators' beliefs about the long-run fundamental price of foreign currency e₀:

In this model with flexible prices and with output fixed and equal to potential, analyze the impact of such an increase in government purchases on the economy's equilibrium: what happens to the interest rate, to the exchange rate, to government purchases, to investment, and to gross exports?

(2) In the same setup as problem (1), change the investment function to allow investment to depend on the intensity of financial crisis C, like so:

Restrict your attention to only cases in which the change in the exchange rate e--in the price of foreign currency--are positive. Now solve for the impact on the increase in government purchases on the economy's equilibrium: what happens to the interest rate, to the exchange rate, to government purchases, to investment, and to gross exports?

(3) Go back to problem 1, only solve it in the sticky-price model, where output can change and where the interest rate is a policy variable chosen by the Federal Reserve. What happens to the interest rate, to the exchange rate, to government purchases, to investment, and to gross exports as functions of the change in government purchases and the change in the interest rate? Assuming that the central bank cannot affect the change in government purchases--that that is set in stone by politics--what, in your view, should the central bank do in the way of monetary policy?

(4) Go back to problem 2, only solve it in the sticky-price model, where output can change and where the interest rate is a policy variable chosen by the Federal Reserve. What happens to the interest rate, to the exchange rate, to government purchases, to investment, and to gross exports as functions of the change in government purchases and the change in the interest rate? Assuming that the central bank cannot affect the change in government purchases--that that is set in stone by politics--what, in your view, should the central bank do in the way of monetary policy?

Comments

[Coleman Maher]

when is this due?