14.02 Quiz 2 Solutions Fall 2004 Multiple-Choice Questions

To answer the part about net exports, we need to solve for NX in terms of only foreignoutput.NX = x1 Y* – im 1 Y = x 1 Y* –im 11 − c 1− b 1+ im 1(c 0 – c 1 T – b 2 i* + G+ x 1 Y*)∂NX im = x1 ( 1−1 ) > 0 if c1 + b 1< 1 which is given. (Alternatively, we can∂Y * 1 − c 1− b 1+ im 1imwrite this as ∆NX= x 1( 1−1 )∆Y * .)1 − c 1− b 1+ im 1Again, there are two opposing effects: on one hand, an increase in foreign output, Y*,increases exports. On the other hand, higher exports result in higher domestic GDP,which leads to higher imports. However, again, the first effect dominates (because theMarshall-Lerner condition is satisfied).The domestic interest rate and the real exchange rate do not change, because of thefixed exchange rate regime. So, i=i* and ε=14. Suppose the Central Bank implements expansionary monetary policy. What effectwill this have on output (Y), net exports (NX), the domestic interest rate (i), and thereal exchange rate. Also draw a diagram. (4 points)Expansionary monetary policy has no effect on any of the four variables mentioned inthe question, because monetary policy is endogenous in a fixed exchange rate regime.iLMLM’ii=i*i’YISY’YE=1 E’Interest parityconditionE