Problem 1.(10 points) Which of the following statements are true? Which are false? Explain (for each statement)

1. Unlike money supply targeting, the crawling peg policy uses the exchange rate as a nominal anchor.
2. Real interest rates will converge for two countries that do not trade in goods or assets.

Problem 2.(30 points) Recession vs. fiscal policy vs. inflation. You are an economist hired by the government of Blankistan. Your task is to assess economic outcomes of policies that the government proposes. You know that for the last three years Blankistan has been suffering from a recession. The government would like to stimulate the economy by cutting personal income tax.

1. Make a prediction about the future government budget deficit: how will it be affected by 1) a prolonged recession 2) a tax cut?
2. Suppose now the government of Blankistan is considering asking the central bank of Blankistan to print money at a higher rate to cover growing budget deficit. Assess the benefits and drawbacks of such policy choice.
3. What do you expect to happen to the exchange rate (Blankistan has a floating exchange rate regime)?

Problem 3.(40 points) Monetary approach and policy. You are an economist working for Czech National Bank. Consider the economy of Czech Republic and suppose relative PPP and the quantity theory of money hold. Suppose you expect the rate of money growth of Czech Republic in the 2021 to be around 4% while your forecast for its real GDP growth is at 1%. Suppose inflation in the UK is expected to be at 2%. Currently, Czech National bank has a floating exchange rate.

1. Use monetary approach to determine the expected inflation rate in Czech Republic for the year 2021.
2. By how much do you expect the British Pound to appreciate/depreciate against the Czech Koruna in the year 2021?

Now consider how the Czech economy will respond to the Czech National Bank changing their monetary policy regime. Below are some forecasts for years 2021-2022.