PROBLEM SET #2
1. True, False or Uncertain: Explain
i)
In an open economy DD-AA model, a permanent increase in domestic
government purchases leads to an increase in domestic equilibrium interest rate
and output, and results into a depreciation of domestic currency against foreign
currency in the short run. [Diagram required]
ii)
Under flexible exchange rates, monetary expansion causes the current account
balance to increase in the short run.
iii)
Both the temporary and permanent expansionary fiscal policy improves the current
account balance. [Diagrams required]
iv)
If the economy, which is under a flexible exchange rate system, starts at longrun equilibrium, a permanent tax cut will cause its currency to appreciate but
will have no effect on output in the short-run. [Diagram required]
2.
Explain how does an increase in the real exchange rate affect exports and imports?
3
Imagine that the economy is at a point on the DD-AA schedule that is above both AA and
DD and where both the output and asset markets are out of equilibrium and Y is less than
equilibrium output. Explain what will happen next and how the economy gets to
equilibrium in both markets?
4.
Using a figure show that under full employment, a temporary fiscal expansion would
increase output (over-employment) but cannot increase output in the long run, under
flexible exchange rates