Consider the DD-AA model. The domestic economy follows the standard framework discussed in ECOS3007, i.e. the...

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Consider the DD-AA model. The domestic economy follows the standard framework discussed in ECOS3007, i.e. the equilibrium in the goods market is Y = C(YT) +I+G+CA(EP*/P,Y – T). The interest-parity condition and the money market equilibrium are given by Ee E E R=R* + M P = L(R,Y) . Other assumptions are standard: purchasing power parity (PPP) holds in the long run, market participants are rational (expectations may change), output is equal to its potential level in the long run, etc. I, G, and T are exogenous (unless otherwise notified). For now, assume that the foreign homy has an identical representation as the domestic economy described above. (a) Analyze what happen in the short run in the domestic economy when the foreign economy's central bank decides to increase their money supply (M* ↑) temporarily by a given amount. [10 points] Now suppose that the foreign economy's aggregate investment depends posi- tively on the domestic economy's output: I* = I*(Y). The domestic economy's representation remains unchanged. (b) Redo question (a). What happen to E, Y, and CA? Is it possible for the domestic output Y to increase in the short run? Explain. [13 points] (c) While still assuming I* = I*(Y), analyze what happen if the increase in foreign money supply is permanent instead? [12 points] Consider the DD-AA model. The domestic economy follows the standard framework discussed in ECOS3007, i.e. the equilibrium in the goods market is Y = C(YT) +I+G+CA(EP*/P,Y – T). The interest-parity condition and the money market equilibrium are given by Ee E E R=R* + M P = L(R,Y) . Other assumptions are standard: purchasing power parity (PPP) holds in the long run, market participants are rational (expectations may change), output is equal to its potential level in the long run, etc. I, G, and T are exogenous (unless otherwise notified). For now, assume that the foreign homy has an identical representation as the domestic economy described above. (a) Analyze what happen in the short run in the domestic economy when the foreign economy's central bank decides to increase their money supply (M* ↑) temporarily by a given amount. [10 points] Now suppose that the foreign economy's aggregate investment depends posi- tively on the domestic economy's output: I* = I*(Y). The domestic economy's representation remains unchanged. (b) Redo question (a). What happen to E, Y, and CA? Is it possible for the domestic output Y to increase in the short run? Explain. [13 points] (c) While still assuming I* = I*(Y), analyze what happen if the increase in foreign money supply is permanent instead? [12 points]

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a When the foreign economys central bank decides to increase their money supply M temporarily by a g... View the full answer