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    Seminar Activity 3 - 2024

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    angela.figueras
    Macroeconomics UPF GTIAE

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    Seminar Activity 3 - 2024

    Uploaded by

    angela.figueras
    7 views2 pages
    Macroeconomics UPF GTIAE

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    Seminar activity 3_2024

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    Macroeconomics UPF GTIAE

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    7 views2 pages

    Seminar Activity 3 - 2024

    Uploaded by

    angela.figueras
    Macroeconomics UPF GTIAE

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
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    Seminar activity 3

    As an economic advisor, you are asked to analyze the short-run effects of a change in the FED policy on
    both sides of the Atlantic. The US variables will be denoted with stars (i.e., 𝑌 ∗ ), as they represent a foreign
    economy from the point of view of the Eurozone. Through the question, assume 𝑃∗ = 𝑃 = 1.

    The latest values are (approximately) 𝑖 ∗ =0.05 (or 5%) and 𝑖 =0.04 (or 4%).

    1) Short-run effects of the FED policy in the U.S. economy.

    Consider the U.S. as a closed economy with the following 𝐼𝑆 relationship:

    𝑌 ∗ = 400 − 1250𝑖 ∗

    where 𝑌 ∗ denotes U.S. output in billions of dollars and 𝑖 ∗ U.S. nominal interest rate (in decimal points).

    Money demand 𝑀"∗ in the U.S. is given by:

    𝑀"∗ = 𝑃∗ (𝑌 ∗ − 625𝑖 ∗ )

    where 𝑃∗ denotes US price level.


    a) Solve for the equilibrium output and money supply during the zero lower bound period.
    b) Consider now an increase in the interest rate to 𝑖∗ = 0.05. What are the new equilibrium output
    and money supply?
    c) The Federal Reserve had to ___________ (buy / sell) _______ billions of government bonds to
    _____________ (contract / expand) the monetary base, and US government bond prices have
    ________________ (increased / decreased).

    2) Short-run effects of the FED policy in the Eurozone economy.

    Consider the Eurozone as a small open economy with a flexible exchange rate that can be described with
    the following 𝐼𝑆 relationship:
    𝑌 ∗ 60
    𝑌 = 50 − 2000𝑖 + +
    8 𝜀
    where 𝑌 and 𝑖 denote Eurozone output and ECB nominal interest rate, 𝑌 ∗ denotes U.S. output and 𝜀 the
    real exchange rate.

    Money demand 𝑀" is given by:

    𝑀" = 𝑃(0.5𝑌 − 25𝑖)

    where 𝑃 denotes the price level.


    During the years of the ZLB on both sides of the Atlantic, the nominal exchange rate was equal to 𝐸 =
    1.2 dollars/euro.

    Please answer the following questions:

    a) Solve for the equilibrium output and money supply in the Eurozone during the ZLB period,
    considering your answers for the US in the previous exercise. Assume the UIP holds.

    b) According to the UIP, what were the exchange rate expectations 𝐸𝑒 during the ZLB period?

    c) Now compute the new equilibrium (output and real exchange rate) after the interest rate increases
    to 𝑖∗ = 0.05 and 𝑖 = 0.04. For your answer, assume that the UIP holds and that 𝐸𝑒=1.

    d) Given the exchange rate expectations and the interest rate differentials, the euro has suffered
    a___________ (depreciation/appreciation) of ________ % with respect to the dollar.

    e) Show graphically in an IS-LM-UIP diagram the equilibrium of the Eurozone economy at the ZLB
    and in recent years. Make sure to label clearly curves, axis, and equilibrium points.

    f) Describe in words the developments in the Euro/U.S. dollar exchange rate, output levels, and
    nominal interest rates in the Eurozone before and after the increases in the domestic and foreign
    interest rates.

    g) Suppose the ECB decided to fix the exchange rate euro/dollar at 𝐸 = 𝐸𝑒=1. Also, suppose that in
    December, the FED raises interest rates an additional 100 basis points to reach 𝑖∗ = 0.06.
    According to the UIP, what interest rate should the ECB set? What would the new equilibrium
    look like in the eurozone? Draw a diagram to illustrate your answer under this scenario.

    h) What policy would you recommend to the ECB (flexible or fixed exchange rate) and why?

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