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ECN 410

Problem Set 4

Due Friday 11/19

1. Use the DD-AA model to show how the European Central Bank implementing expansionary monetary policy can impact the US. Does the change abroad impact the goods market, asset market or both? Illustrate and explain. Is the result conclusive? Why or why not?

2. Use the volume and value effects to illustrate and explain the short-run behavior of exchange rates that face pressure to depreciate. How might the potential for exchange rate pass through impact this process?

3. Use the DD-AA model to answer the following. Make sure to show the original effects in the goods or asset markets that drive the changes in e and Y in the DD-AA total market:

a) The government passes a corporate tax increase. 

b) How would your answer to part a change if the central bank adhered to a fixed exchange rate system?

4. Use the DD-AA market to show how a country offsets recessionary pressure at home to maintain its fixed exchange rate. Would such sterilization require open market purchases or sales? If the recession is prolonged, does this present a problem to the viability of the currency’s current peg? Why or why not?