A small open economy is described by the following equations: / C=0,99 7 0,17 +10 1000...

 

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A small open economy is described by the following equations: / C=0,99 7 0,17 +10 1000 100 150E IM=0,21Y-50E L 0,5Y-800 + 75 M = 200 X Capital mobility is perfect. The exchange rate is flexible, but domestic and foreign prices are fixed and normalized to unity. Initially, the exchange rate (E) is equal to 1, but this can change after a shock. a) Knowing that the speed of adaptation is equal to 0.5 and that the long-term exchange rate has a unit value, calculate the effect of a 100-unit increase in G on national income, the interest rate and the exchange rate. b)Explain this effect economically. c) Give and explain the factors that may reduce the effect of public spending in this economy. A small open economy is described by the following equations: / C=0,99 7 0,17 +10 1000 100 150E IM=0,21Y-50E L 0,5Y-800 + 75 M = 200 X Capital mobility is perfect. The exchange rate is flexible, but domestic and foreign prices are fixed and normalized to unity. Initially, the exchange rate (E) is equal to 1, but this can change after a shock. a) Knowing that the speed of adaptation is equal to 0.5 and that the long-term exchange rate has a unit value, calculate the effect of a 100-unit increase in G on national income, the interest rate and the exchange rate. b)Explain this effect economically. c) Give and explain the factors that may reduce the effect of public spending in this economy.

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To solve this problem well use a simple open economy model where the equilibrium conditions are determined by the equality of domestic savings and investment as well as the balance of payments equilib... View the full answer