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Questions › DSE › DSE 2009 › Q54
2 marksInternational Economics › Open-economy macroeconomics › Policy under fixed exchange ratesHardabout 4 min

DSE 2009 Question 54: Open-economy macroeconomics

Setup, from Q51 of the paper:

An economy is described by a goods-market equilibrium Y=C(Y)+I(r)+G+NX(Y,e)Y=C(Y)+I(r)+G+NX(Y,e)Y=C(Y)+I(r)+G+NX(Y,e) and a money-market equilibrium M/P=L(Y,r)M/P=L(Y,r)M/P=L(Y,r), with C=Cˉ+σ(Y−T)C=\bar C+\sigma(Y-T)C=Cˉ+σ(Y−T), T=τYT=\tau YT=τY, I=Iˉ−δrI=\bar I-\delta rI=Iˉ−δr, NX=Xˉ−μY−γeNX=\bar X-\mu Y-\gamma eNX=Xˉ−μY−γe, L=Lˉ+αY−βrL=\bar L+\alpha Y-\beta rL=Lˉ+αY−βr, and r=rˉr=\bar rr=rˉ, M=MˉM=\bar MM=Mˉ, P=PˉP=\bar PP=Pˉ fixed. Drawing IS and LM in the (Y,e)(Y,e)(Y,e) plane with YYY horizontal and eee vertical. In this case

(Same model.) If the government arbitrarily fixes the real exchange rate at some eˉ\bar eeˉ,

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Plain-text version

Setup, from Q51 of the paper: An economy is described by a goods-market equilibrium Y=C(Y)+I(r)+G+NX(Y,e) and a money-market equilibrium M/P=L(Y,r), with C=C̄+σ(Y-T), T=τ Y, I=Ī-δ r, NX=X̄-μ Y-γ e, L=L̄+α Y-β r, and r=r̄, M=M̄, P=P̄ fixed. Drawing IS and LM in the (Y,e) plane with Y horizontal and e vertical. In this case (Same model.) If the government arbitrarily fixes the real exchange rate at some ē, (A) the two markets can be simultaneously in equilibrium only under special parametric restrictions (B) the two markets can be simultaneously in equilibrium if the government follows an accommodating interest rate policy (C) the two markets can be simultaneously in equilibrium if the government follows an accommodating money supply rule (D) all of the above

Also written as: Setup, from Q51 of the paper: An economy is described by a goods-market equilibrium Y=C(Y)+I(r)+G+NX(Y,e) and a money-market equilibrium M/P=L(Y,r), with C=C_bar+sigma(Y-T), T=tau Y, I=I_bar-delta r, NX=X_bar-mu Y-gamma e, L=L_bar+alpha Y-beta r, and r=r_bar, M=M_bar, P=P_bar fixed. Drawing IS and LM in the (Y,e) plane with Y horizontal and e vertical. In this case (Same model.) If the government arbitrarily fixes the real exchange rate at some e_bar,

Open-economy macroeconomics has come up 55 times in 7 exams since 2006.

What this question tests

This question is on Policy under fixed exchange rates, part of Open-economy macroeconomics in International Economics.

What monetary and fiscal policy can do when the central bank holds the exchange rate.

TestStop has 13 past-paper questions on this subtopic.

Practise Open-economy macroeconomicsMore on Policy under fixed exchange rates

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Question from the DSE 2009 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.