1. Consider the Mundell-Fleming Model with fixed exchange rate. The central bank announces a fixed exchange rate e* = 1.8. The goods market is characterized by the following equations:
G = T = 100,
C = 100 + 0.8(Y - T),
I = 100 - r,
X = 100 - 10e.
The demand for real money balance is (M/P)^d= Y - 10r. And the aggregate price level is 1. The world interest rate is r* = 10.
(a) Find equilibrium income and the quantity of nominal money supply to support the fixed exchange rate.
2. Consider the Mundell-Fleming Model with semi-fixed exchange rate. Specifically, the central banks commits not to a fixed exchange rate, but to an interval [e1, e2 ¯]. That is, domestic exchange rate can fluctuate within this interval. And once the exchange rate moves outside the interval, the central bank will use monetary policy to intervene and restore the exchange rate. Suppose e1 = 1.6 and e2 = 1.8.
The goods market is characterized by the following equations:
G = T = 100,
C = 100 + 0.8(Y - T),
I = 50 - r,
X = 50 - 100e.
The demand for real money balance is (M/P)^d = Y - 10r. And the aggregate price level is 100, and the current money supply is 200. The world interest rate is r* = 10.
(a) Show that the current market exchange rate is outside the given interval.
(b) Find the minimum increase (or decrease) in money supply to restore the exchange rate back to the interval.