1. For each of the following situations, use the IS-LM-FX model to illustrate the effects of the shock.
In each case, determine whether monetary and/or fiscal policy can be used to stabilize output, and determine the effects of the policy response on domestic output, the domestic nominal and real interest rate, the exchange rate, domestic consumption and domestic investment.
a. An increase in the foreign interest rate under fixed exchange rates.
b. An increase in the foreign interest rate assuming flexible rates.
2. For each of the following situations, use the IS-LM-FX model to illustrate the effects of the shock.
a. An increase in the home money supply fixed exchange rates.
b. An increase in the home money supply under flexible rates.
3. Poland and Latvia pursued very different monetary and fiscal policies during the Great Recession. Use the posted readings together with the IS-LM-FX diagram and the book discussion to provide an explanation of the goals of each country, the policies used, and the extent to which each was successful, or is likely to be successful in the future. (There is no single ‘perfect' answer. Try to apply what you've learned.) Updates on the past year:
4. Exchange rate regimes:
a. Discuss the pros and cons of a gold standard. Based on the considerations that make a fixed rate system desirable, do you think those considerations are more true today or were more true during the gold standard?
b. What was the argument for a bimetallic standard? What happened to end the discussion?
c. Which pair of countries would make a more effective fixed exchange rate region: US-Canada or US- Mexico? Why?
5. Developing countries have more severe output costs of exchange rate crises and take longer to recover from exchange rate crises. Discuss 3 reasons why this may be the case.
6. Consider an open economy, Poland, with money supply equal to 600 billion zlotys and a backing ratio of 20%. The exchange rate is 3 zlotys per dollar, and all reserves are US$.
a. What is the Central Bank's holdings of US dollars?
b. Poland is in no apparent hurry to join the Euro zone. What has happened to the zloty/Euro exchange rate over the past 5 years? Does this surprise you? Why or why not? What do you think is the goal of Polish monetary policy, given the recent history of the exchange rate?
c. Poland is recording a trade surplus for 2014. What will be the effect of this on (i) the Polish money supply, and (ii) the backing ratio? What can Poland do to avoid this effect?
d. As a result of inflation in the early 1990s, the currency underwent redenomination. Thus, on January 1, 1995, 10,000 old záotych (PLZ) became one new záoty (PLN). What is another word for this process of ‘redenomination'?