The curves LM(ASN) and LM*(AS7v ) are drawn in the left-hand panel of Figure 11.9, and coincide in the initial equilibrium due to the symmetry assumption. The goods market equilibrium schedule under nominal wage rigidity, GME N, is obtained by substituting LM(ASN) into the IS curve and solving for r* in terms of the real exchange rate and the exogenous variables (and similarly for GMEN):

(1 WNENWEMY) [EyQq + EyG(g + rig* )] + coNENw (vvo — m] r* =

EYR ( 1 WNENWEMY) WNENWEMR

(1 + WNENWEMY) HIV/ ± EYAr + 77g)] + (DNENw [11 — m*]

r* =

EYR ( 1 (NENWEMY) (.ONENWEMR GMEN is upward sloping in (r*, q) space because a real depreciation (a rise in q)

stimulates domestic output and, consequently, the demand for real money balances.

Money market equilibrium can only be restored if the interest rate is higher (the slope of GMEN is reversed since —q measures the real exchange rate from the foreign country's perspective).

VIVEA4-wW;

(11.49)

(LM(ASN))

(LM*(Ag,))

(GMEN)

(GMEN)

r*

LM (ASN)

LM*(ASN*)

The Foundation of Modern Macroeconomics LM (ASN) i Y,Y* Yi=h * Yo=Yo* 0 q1 go Figure 11.9. Fiscal policy with nominal wage rigidity in both countries Figure 11.10 in both cot..