Question

1. Use the money market and foreign exchange (FX) diagrams to answer the following questions. This...

1. Use the money market and foreign exchange (FX) diagrams to answer the following questions. This question considers the relationship between the euro (e) and the U.S. dollar ($). Let the U.S. be “Home” and the European Monetary Union (EMU) be “Foreign”. Let the exchange rate be defined as U.S. dollars per euro, E$/e. Assume, for simplicity, that European money supply, M∗ , liquidity preferences L ∗ , price level P ∗ , nominal and real interest rates, i ∗ and r ∗ , and output, Y ∗ , are fixed in the short and long run; for the U.S., output Y is fixed in the short and long run. All other variables – M, P, i, r, Ee , E – are assumed to be steady and at constant levels in the long run. Furthermore, prices in the U.S. are assumed to be “sticky” (fixed) in the short run. Suppose that with financial innovation in the United States, real money demand in the United States decreases (i.e., LUS(·) ↓ for any given nominal interest rate i). Clearly label your graphs. On all graphs, label the initial equilibrium point A. (a) Assume this change in U.S. real money demand is temporary. Using the FX/money market diagrams, illustrate how this change affects the money and FX markets. Label your short-run equilibrium point B and your long-run equilibrium point C. (b) Assume this change in U.S. real money demand is permanent. i. Using a new diagram, illustrate how this change affects the money and FX markets. Label your short-run equilibrium point B and your long-run equilibrium point C. ii. Illustrate how each of the following variables changes over time in response to a permanent reduction in real money demand: • nominal money supply MUS, • price level PUS, • real money supply MUS/PUS, • U.S. interest rate i$ , • and the exchange rate E$/e.

Homework Answers

Answer #1

Part A

In the diagram, the long run values are the same because the shock is temporary. Also, we know that the temporary shocks give a reversal of money demand before the price level adjusts. So, MD returns to MD2 to MD1 even before the price changes.

Part B

In the long run, the level of prices increases to adjust the money demand. Because the central bank cannot change the money supply. So, the nominal rate of interest return to initial values. For this, the price level should increase to reduce the money supply. That means the reduction of the money supply will intersect the money demand. The exchange rate would change because the shock is permanent. FX curve also shifts upwards.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Use the foreign exchange and money market diagrams to answer the following questions about the relationship...
Use the foreign exchange and money market diagrams to answer the following questions about the relationship between the Indian rupee (INR) and the Euro (EUR). Let the exchange rate be defined as rupees per yuan EINR/Eur. Suppose there is a fall in the Indian nominal money supply. Make the usual assumptions: UIP holds, PPP holds in the long run, prices are sticky in the short run, (20p) -- Now assume instead that the fall in money supply is permanent. Illustrate...
Use the money market and FX diagrams to answer the following questions about the relationship between...
Use the money market and FX diagrams to answer the following questions about the relationship between the British pound (£) and the U.S. dollar ($). The exchange rate is in U.S. dollars per British pound E$/£. We want to consider how a change in the U.S. money supply affects interest rates and exchange rates. On all graphs, label the initial equilibrium point A. a. Illustrate how a temporary increase in the U.S. money supply affects the money and FX markets....
Use the money market and FX diagrams to answer the following questions about the relationship between...
Use the money market and FX diagrams to answer the following questions about the relationship between the Home and the foreign currency (Eh/f: home in terms of foreign; per unit (1) foreign currency). Consider how a change in foreign Money supply affects interest rates and exchange rates. On all graphs, label the initial equilibrium point A. a) Illustrate graphically how a temporary decrease in the foreign Money supply affects the money and FX markets in the short run and in...
Use the money market and FX diagrams to answer the following questions about the relationship between...
Use the money market and FX diagrams to answer the following questions about the relationship between the Home and the foreign currency (Eh/f: home in terms of foreign; per unit (1) foreign currency). Consider how a change in foreign Money supply affects interest rates and exchange rates. On all graphs, label the initial equilibrium point A. a) Illustrate graphically how a temporary decrease in the foreign Money supply affects the money and FX markets in the short run and in...
2. Using a figure describing both the U.S. money market and the foreign exchange market, analyze...
2. Using a figure describing both the U.S. money market and the foreign exchange market, analyze the effects of an increase in the U.S. money supply on the dollar/euro exchange rate. 3. What are the main factors that determine aggregate money demand? Why does the real money demand curve slope downward? 4. What is the expected dollar rate of return on euro deposits if today's exchange rate is $1.10 per euro, next year's expected exchange rate is $1.165 per euro,...
Explain how permanent shifts in national real money demand functions affect real and nominal exchange rates...
Explain how permanent shifts in national real money demand functions affect real and nominal exchange rates in the long run.
Explain how permanent shifts in national real money demand functions affect real and nominal exchange rates...
Explain how permanent shifts in national real money demand functions affect real and nominal exchange rates in the long run.
Discuss the linkages between the money market and the foreign exchange market in both the short...
Discuss the linkages between the money market and the foreign exchange market in both the short and long-run? (You should use (lots of) graphs in this question)
3. Use the classical model of a closed economy and the quantity theory of money to...
3. Use the classical model of a closed economy and the quantity theory of money to predict how each of the following shocks would affect real aggregate income (Y), the real interest rate (r), and the price of goods and services (P) in a closed economy in the long run, all else equal. For each shock, be sure to clearly state a prediction for all three variables (up, down, or no change) and illustrate your predictions with supply/demand diagrams for...
How each of the following changes will affect the nominal exchange rate (dollars per euro) according...
How each of the following changes will affect the nominal exchange rate (dollars per euro) according to the real exchange rate approach: a.The relative demand of U.S. products decreases. b.The relative demand of U.S. products decreases. c.The US money supply increases