Home signs a free-trade agreement with Foreign, which lowers tariffs and other barriers to trade. Both countries are very similar in terms of economic shocks, as they each produce very similar goods. Use a symmetry-integration diagram as in Figure 8-4 (19-4) as part of your answer to the following questions.
See the following figure. Initially, the countries face similar shocks, as shown by Point A.

a. Initially, trade rises. Does the rise in trade make Home more or less likely to peg its currency to the Foreign currency? Why?
b. In the longer run, freer trade causes the countries to follow their comparative advantage and specialize in producing very different types of goods. Does the rise in specialization make Home more or less likely to peg its currency to the Foreign currency? Why?

Transcribed Image Text:

Symmetry of shocks FIX Market integration