Problem Set # 9
International Finance
Miguel D. Ramirez
Spring 2000
1. Suppose you are given the following numerical expressions for a small economy under fixed exchange rates and perfect capital mobility. Figures are in billions of pesos except for the interest rate (i).
A= 500 + .8Y -200i, T= 100 - .2Y, i*= .10
a. Determine the equilibrium levels of output, trade balance, capital account, and balance of payments.
b. Suppose there is an exogenous decrease in domestic investment expenditures of 50 billion pesos. What are the effects on the equilibrium levels of output, trade balance, capital account, and balance of payments?
c. If policymakers decide to simulate the economy to offset the decline in investment in part b, is it necessary for them to undertake both expenditure-changing and switching-policies? Explain fully.
2. Using the IS-LM-BP apparatus, discuss the impact of contractionary monetary policy for a small economy under flexible rates and perfect capital mobility. Explain fully.
3. In class we developed an analytical model to explain the so- called "overshooting" exchange rate phenomenon. Briefly explain the underlying assumptions of this model. Suppose now that the monetary authorities increase the money supply in order to stimulate economic growth. What impact will this expansionary policy have on the short- and long-run values of the spot and forward rates, interest rate, price level, and level of income. (Hint: a set of graphs might be useful.)