Short question: In a post-Brexit world, imagine that a tariff must now be paid on goods imported from the European Union to the UK, and that this new tariff is permanent. Assuming that purchasing power parity holds both before and after the tariff is imposed, derive a condition linking changes in the Euro-Pound exchange rate E to the size of the new tariff. Using that condition, and assuming that real interest rates in the UK and the European Union are zero, and that the Bank of England decided to peg the Pound to the Euro, derive a condition linking nominal interest rates in the UK to the size of the new tariff. In response to an expected increase in the new tariff rate, will the Bank of England have to permanently raise, lower, or leave unchanged the nominal interest rate on reserves? Discuss the economic intuition for this result, regardless of whether you derived the mathematical expression.

Imagine an economy with two sectors, construction c and manufacturing m, and two firms within the manufacturing sector, firm b and firm g. The production function of the construction sector is y_c = z_ck_c , where < 1 and z_c is the level of productivity. The production function of the manufacturing sector is y_m = z_mk_m , with the same 0alpha but a different level of productivity z_m. The capital in the manufacturing sector though can be provided by the g firm in kg, or the b firm by kb, so that < 1 reflects the lower productivity of firm b in producing this capital. Therefore, km = kg = kb. All firms and sectors compete for renting capital to their activity in a market where capital must be paid at the rate r. The prices of the goods of each are p_m and p_c. What is the ratio of capital across the two sector km/kc in an equilibrium where both firms face the same interest rate r and compete for renting this capital? How does it depend on the relative prices of the goods of the two sectors, and on their relative productivity.