Policy trade-offs Imagine that the Reserve Bank would like lower interest rates to stimulate the economy, but is worried that low interest rates would be bad for importers. 1. Why might lower interest rates stimulate the economy? 2. Why might lower interest rates be bad for importers? 3. Is this dilemma more or less serious when international capital flows very freely? Q2 Exchange rates and inflation Assume that New Zealand maintains a floating exchange rate. If the change in New Zealand's price level is lower than that of its trading partners, 1. what impact would this have on the nominal exchange rate? 2. what (long-run) impact would this have on the real exchange rate? Q3 UIP Referring to the diagram below, what does uncovered interest parity imply about the value of Et given it, if and Efti? Why? Suppose that At = $1000, 4 = 3%, if = 1% and Eff, = $0.7845. What does uncovered interest parity imply about the value of the current (spot) exchange rate? At At Et Xt+1 (1 + ;; ) A,Et