In the text, we examined how government deficits affect the country’s ability to defend a peg using a first-generation model. Suppose an economy has $5,760 billion in money supply and $4,000 billion in domestic credit. Assumeand . The economy begins in year 1. For the following questions, assume investors are myopic and billion.

a. Calculate the central bank’s reserves and backing ratio.

b. The government begins running an unanticipated deficit that grows by 20% each year. The initial budget deficit in year 2 is equal to $800 billion. Calculate the central bank’s reserves, money supply, and backing ratio for years 1 through 5.

c. Based on the previous information, at what time is the central bank forced to float? Calculate the inflation rate and rate of depreciation under the fixed regime and after the country floats.

d. Using the Fisher effect, calculate the new interest rate in this economy. Suppose this change in the interest rate causes to decrease from 1 to 0.75. Calculate real money demand under the fixed exchange rate regime and under the floating exchange rate regime.

e. Illustrate the behavior of the following variables between and : domestic credit, reserves, and the money supply.

f. Illustrate the behavior of the following variables between and : the nominal interest rate, the price level, and the exchange rate.