This leads Lo difficult policy Choices for the government and central! & . SOLVE the uncovered Interest Tale Family Condition for LATE bank . The equations that describe the economy are ." value of the domestic interest rate in period ] ." The IS curve :` b. In period ?, the crisis begins . Solve the uncovered interest* Y = V / EP ( P * . G . I . * - THE * ) rate parity condition for the value of the domestic interest rate in period 2 . ( - . 4 . _ .` + ) C. The crisis continues in period 3 . However , in period 4 , the cell - tral bank and government resolve the crisis . How does this occur ? The Phillips curves for the domestic and the foreign economy :" J. Unfortunately , in period 5 , the crisis returns bigger and Domestic Phillips curve* TT - TT = ( all ) ( Y - I'm ) deeper than ever . Has the central bank raised interest rates* enough to maintain uncovered interest rate parity ? What are* Foreign Phillips curve* IT* - TT* = ( `* / 1.* ) (Y* - `) the consequences for the level of foreign exchange reserves ?" In the text and in this question , we are going to make two critical* c. How is the crisis resolved in period 6 ? Does this have impli- assumptions . These are explored in parts ( 1 ) and ( b ) . Then we move* cations for the future credibility of the central bank and the to the analysis of the policy options when a country is experiencing Government ?" an overvalued exchange rate .* 5 . Modeling the movement's in the exchange rate* ` . We are going to assume that the foreign economy is always* Equation ( 20. 5 ) provides insight into the movements of in medium - run equilibrium . What are the implications of nominal exchange rates between a domestic and a foreign country that assumption for foreign output and foreign inflation ?" Remember that the time periods in equation can refer to any time* 6 . We are going to assume that the domestic and foreign unit . The equation is :` economies share the same anchored value for the level of expected inflation denoted { and }*. What is the implica - HI = . ( 1 + 1 1 ) ( 1 + 1{ + 1 ) . . . ( 1 + { + n ) - Eith + ! Lion of that assumption once both the domestic and foreign* ( 1 + 1 * ) ( 1 + 1 7 4 1 ) . . . ( 1 + * * { n )` economies are both in medium - run equilibrium ?"\ `. Suppose we are thinking of one- day time periods . There are* C. Draw the IS_ L.M - LIP diagram for the case where the domes overnight ( 1 - day ) interest rates . How do we interpret a large* lic country has an overvalued nominal exchange rate . What movement in the exchange rate over the course of the day is the key feature of that diagram ? Under fixed exchange if we do not observe any change in the 1 - day interest rate ?" rates without a devaluation , how does the economy return b . We learned in Chapter 15 that a one - month ( 30 - 05 3 1 - day to it's medium -run equilibrium ? interest rate ) is the average of today's 1- day rate and the J. Draw the IS- IM - UIP diagram for the case where the do- expected 1 - day rates over the next 30 days . This will be true mestic country has an overvalued nominal exchange rate. in both countries . The following headline is observed on Show how the economy can return to its to medium - run* February 1 : " ECB predicted to cut interest rates February* equilibrium when a devaluation is a policy choice .* 14 , dollar rises . " Does the headline make sense ?" C. Recall that the assumption has been made that interest rate* C. We learned in Chapter 15 that a two - year bond yield is the parity holds so i = ;" at all times . Compare the returns on average of today's one - year interest rate and the expected the domestic bond and the returns on the foreign bond in* one - year rate one year from now . This will be true in both the period of the devaluation . Will bond holders continue to countries . The following headline is observed on February believe there is a completely fixed nominal exchange rate ? It 1 : " Fell announces that interest rates will remain low for the bond holders believe another devaluation is possible , what foreseeable future , dollar falls . " Does the headline make sense ?" are the consequences for domestic interest rates ?" d . The current account is this period 's lending to ( if positive ) or 1 . Modeling an exchange rate crisis* borrowing from ( if negative ; the rest of the world . Assume An exchange rate crisis occurs when the peg ( the fixed exchange the current account is more negative than expected and mate ) loses its credibility . Bond holders no Longer believe that next this is surprising news . Explain why the exchange rate period's exchange rate will be this period's exchange rate . The* would depreciate on this surprising news .\ willcovered interest rate parity equation used is the approximation DIG DEEPER ( Fix I - $1 ) My EconLab Visit www .my econlab . com to complete all Dig Deeper problems and get instant feedback . 6 . Realignments of exchange rate\ Period Look all Figure I in the but" The 1992 EN Crisis ." *European