Assume Denmark is the home economy. The National Bank of Denmark (its central bank) targets the...

  

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Assume Denmark is the home economy. The National Bank of Denmark (its central bank) targets the exchange rate. Namely, it adjusts the amount of Danish Krones in circulation (money supply) in order for the exchange rate EDKr/€ = 7.5 at all times. The prices of goods and services are constant in the short-run but flexible in the long-run. The liquidity component in the demand for money has the following functional form: L(i) = 0.12 - i in Denmark and Germany. The long-run equilibrium real interest rate in Germany and Denmark is 2%. The longrun real exchange rate between Denmark and Germany is 1. German GDP has remained constant at 3,500 (billion) units and the European Central Bank (ECB) has kept the money supply constant in Germany at 3,500 (billion) euros. Danish GDP has remained constant at 350 (billion) units. Explain the equations used to arrive at the answers to the questions below. i) What is the price level in Germany? ii) What is the long-run money supply in Denmark that is required for the nominal exchange rate to hit the target of EDKr/€ = 7.5 in the long run. iii) Germany and Denmark have achieved their long-run equilibrium with constant money supply and GDP before Germany experiences a temporary recession that reduces German GDP to 3181.82 units in the short-term. The ECB does not change its money supply as a result of the recession in German. How does the nominal interest rate on German bonds respond to the temporary fall in German GDP? How does the National Bank of Denmark respond to keep the exchange rate at EDKr/€ = 7.5? Assume Denmark is the home economy. The National Bank of Denmark (its central bank) targets the exchange rate. Namely, it adjusts the amount of Danish Krones in circulation (money supply) in order for the exchange rate EDKr/€ = 7.5 at all times. The prices of goods and services are constant in the short-run but flexible in the long-run. The liquidity component in the demand for money has the following functional form: L(i) = 0.12 - i in Denmark and Germany. The long-run equilibrium real interest rate in Germany and Denmark is 2%. The longrun real exchange rate between Denmark and Germany is 1. German GDP has remained constant at 3,500 (billion) units and the European Central Bank (ECB) has kept the money supply constant in Germany at 3,500 (billion) euros. Danish GDP has remained constant at 350 (billion) units. Explain the equations used to arrive at the answers to the questions below. i) What is the price level in Germany? ii) What is the long-run money supply in Denmark that is required for the nominal exchange rate to hit the target of EDKr/€ = 7.5 in the long run. iii) Germany and Denmark have achieved their long-run equilibrium with constant money supply and GDP before Germany experiences a temporary recession that reduces German GDP to 3181.82 units in the short-term. The ECB does not change its money supply as a result of the recession in German. How does the nominal interest rate on German bonds respond to the temporary fall in German GDP? How does the National Bank of Denmark respond to keep the exchange rate at EDKr/€ = 7.5?

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i Price level in Germany 35003500 x 1 1 ii Longrun money supply in Denmark 3500 x 75 088 397727 bill... View the full answer