Flexible exchange rates and foreign macroeconomic events Consider an open economy with flexible exchange rates. Let UIP

Question:

Flexible exchange rates and foreign macroeconomic events Consider an open economy with flexible exchange rates. Let UIP stand for the uncovered interest parity condition.

a. In an IS-LM-UIP diagram, such as Figure 19-2, show the effect of an increase in foreign output, \(Y^{*}\), on domestic output \((Y)\) and the exchange rate \((E)\), when the domestic central bank leaves the policy interest rate unchanged. Explain in words.

b. In an IS-LM-UIP diagram, show the effect of an increase in the foreign interest rate, \(i^{*}\), on domestic output \((Y)\) and the exchange rate \((E)\), when the domestic central bank leaves the policy interest rate unchanged. Explain in words.

Data from Figure 19-2