1. During the Great Depression, countries which had a policy of competitive devaluation (or ‘beggar thy neighbour’) increased net exports by lowering the value of their currency. Using a Mundell-Fleming model with a fixed rate, show the impact of a competitive devaluation without taking account of the output gap. (hint, the exchange rate is ‘fixed’ but only after an initial lowering of its value, which causes a positive NX shock)

2. What is the long run impact of the policy in (1) after taking account of the output gap. Prove that in the long run a competitive devaluation with a fixed rate gives the same long run result as a monetary expansion with a floating rate. What is this result called?

3. Suppose a country experiencing a lockdown has a fiscal expansion to partly compensate for a massive exogenous contraction in consumption. Assume it has a floating rate. Outline the transition to equilibrium and the final state of the expenditure aggregates (but before the consumption or government spending is unwound). You may assume this happens fast enough for there to be no effects on prices.

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1 It may seem counterintuitive but a strong currency is not necessarily in a nations best interests A weak domestic currency makes a nations exports more competitive in global markets and simultaneous... View the full answer