Question
Assume an open economy IS-LM model, in which the economy is open to international financial flows, the uncovered interest parity condition holds, and we are
- Assume an open economy IS-LM model, in which the economy is open to international financial flows, the uncovered interest parity condition holds, and we are analyzing a small open economy so the foreign interest rate is exogenous.
(a) Assume a flexible exchange rate regime and compare the effects of a fiscal expansion to a monetary expansion. Explain the impacts on Y, E and NX using the relevant graphs.
(b) What if the fiscal expansion is accompanied with central bank action to lower the interest rate? Show and explain on a new IS-LM graph.
(c) What might be the motivation of the central bank if it responds in this way?
2.Which bond should an investor choose:
Dollar-denominatedbondEuro-denominated bond
i$=6%i= 8%
spot exchange rate = .90 euro/$1
expected future spot exchange rate = .96 euro/$1
Assume a 1-year time horizon.
Show all calculations. Also, explain in words.
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