DRAW THE GRAPHS OR AT LEAST EXPLAIN WHAT CURVE SHIFTS AND WHY

China joined WTO in December 2001. As a result, the Chinese current account has been increasing and the U.S. current account has been decreasing. Plot a single AA-DD diagram with the U.S. as the home economy (China as the foreign), and the USD/CHY exchange rate on the vertical axis. In the initial equilibrium assume the U.S. is at full employment output () and at the exchange rate at 0. Label the initial equilibrium point "0".

a) Equilibrium point 1. WTO shock with the flexible exchange rate. Trace out the impact of a large decline in current account on U.S. economy in the AA-DD diagram. Assume initially there is no policy response from U.S. and China. Label the new equilibrium point with a "1" and clearly show what happens to U.S. GDP (Y) as well as the USD/CHY exchange rate. Clearly explain the economic intuition behind all the changes in the diagram.

b) Equilibrium point 2. WTO shock with the fixed exchange rate. Now assume that the Chinese central bank pegs its currency to the USD by the FX intervention. Assume that China does not sterilize the intervention. Clearly explain how the Chinese central bank may conduct a FX intervention to fix its currency value against the USD. Trace out the impact of the pegging by the Chinese Central Bank in the AA-DD diagram you drew for (a). Assume there is no policy response from federal reserve or U.S. fiscal authority. Label the new equilibrium point with a "2" and clearly show what happens to U.S. GDP (Y) as well as the USD/CHY exchange rate. Clearly explain the economic intuition behind all the changes in the diagram.

c) Compare the U.S. output in part a (equilibrium point 1) and part b (equilibrium point 2). Based on your answer, explain why President Trump blamed China as a currency manipulator.

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a In the AADD diagram the WTO shock with a flexible exchange rate results in a large decline in the ... View the full answer