Take the following simple open economy: C=360+ 0.3(Y-T) I = 250+ 0.2Y - 1000i G=450 T...

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Take the following simple open economy: C=360+ 0.3(Y-T) I = 250+ 0.2Y - 1000i G=450 T = 100 IM = 0.2Y (Imports in foreign currency) X = 0.2 Y* (Exports in domestic currency) i=i = 0.03 Real Exchange rate, E= 2 Domestic price level, P = 1 (normalized to 1) Foreign price level, P*=1 (normalized to 1) Y*= 1000 (foreign income) a. Calculate the multiplier if the economy is closed and the multiplier if the economy opens up. Explain the economic intuition why the two are different with 3-5 sentences. b. Solve for the equilibrium level of income (Y) for the open economy (Yopen) and calculate the trade balance (NX). c. If government follows an expansionary fiscal policy and G increases by 90, calculate the change in Y for both the closed economy (AY closed) the open economy (AYopen). Assume no change in the foreign income (Y*). Calculate the new trade balance. d. Suppose the interest rate in the foreign economy is 7%, and an investor expects the domestic currency to appreciate relative to the foreign currency by 5% in the coming year, in which bond market in those two economies should the investor invest? e. Suppose the domestic monetary authority decides to reduce the policy interest rate (i) by 2 percentage points to 1%. What would be the effect on the exchange rate? Assuming that the foreign interest rate and the expected appreciation of the exchange rate are the same as in part (d), which bond market should the same investor invest in after the reduction in the domestic policy interest rate? Take the following simple open economy: C=360+ 0.3(Y-T) I = 250+ 0.2Y - 1000i G=450 T = 100 IM = 0.2Y (Imports in foreign currency) X = 0.2 Y* (Exports in domestic currency) i=i = 0.03 Real Exchange rate, E= 2 Domestic price level, P = 1 (normalized to 1) Foreign price level, P*=1 (normalized to 1) Y*= 1000 (foreign income) a. Calculate the multiplier if the economy is closed and the multiplier if the economy opens up. Explain the economic intuition why the two are different with 3-5 sentences. b. Solve for the equilibrium level of income (Y) for the open economy (Yopen) and calculate the trade balance (NX). c. If government follows an expansionary fiscal policy and G increases by 90, calculate the change in Y for both the closed economy (AY closed) the open economy (AYopen). Assume no change in the foreign income (Y*). Calculate the new trade balance. d. Suppose the interest rate in the foreign economy is 7%, and an investor expects the domestic currency to appreciate relative to the foreign currency by 5% in the coming year, in which bond market in those two economies should the investor invest? e. Suppose the domestic monetary authority decides to reduce the policy interest rate (i) by 2 percentage points to 1%. What would be the effect on the exchange rate? Assuming that the foreign interest rate and the expected appreciation of the exchange rate are the same as in part (d), which bond market should the same investor invest in after the reduction in the domestic policy interest rate?

Answer rating: 100% (QA)

a The closed economy multiplier is calculated by 1 M PC where MP C represents the marginal propensity to consume The closed economy multiplier is equa... View the full answer