Using the AA‐DD framework and assuming the flexible exchange rate regime, analyse how a permanent change in tastes of foreign consumers making them to prefer goods produced in their own country over imported goods, would affect domestic economy in the short‐run and in the long‐run. Discuss what would happen to output, the nominal and real exchange rates and the current account. Assume that the economy starts in the long‐run equilibrium with full employment

ECON303

 

International Money and Finance

Instructions: Please answer all questions. Note that the answers have to be typed.  All  questions related to the AA‐DD analysis should contain neatly presented graphs.  The

assignment has to be submitted to turnitin.  Note that apart from correct answers, the clarity of

exposition, the depth of arguments and the overall presentation will be assessed.

 

Question 1 (15 marks) 

 

Using 4‐6 papers from Google Scholar as references discuss the empirical evidence on uncovered

interest parity. (around 800 words is expected)

 

Question 2 (10 marks) 

 

Explain what is meant by the exchange rate pass‐through. In the AA‐DD framework assume that the

exchange rate pass‐through increases from 50% to 80%. Explain how this change would affect the AA

and DD schedules, draw them. Will the effectiveness of temporary monetary and fiscal policies (i.e. their

ability to increase output temporarily) be affected by this change?

 

Question 3 (10 marks) 

 

Using the AA‐DD framework and assuming the flexible exchange rate regime, analyse how a permanent

change in tastes of foreign consumers making them to prefer goods produced in their own country over

imported goods, would affect domestic economy in the short‐run and in the long‐run. Discuss what

would happen to output, the nominal and real exchange rates and the current account. Assume that the

economy starts in the long‐run equilibrium with full employment.

 

Question 4 (15 marks) 

 

 

  1. Using the AA‐DD framework, analyse the effects of a permanent increase in foreign money supply on  the nominal and real exchange rates, domestic output and current account under the flexible exchange

rates. Assume that the economy starts in the long‐run equilibrium with full employment.

 

  1. If the domestic central bank decides to use monetary policy as a response to this change in foreign

monetary policy, what should it do? Will it be effective? How would this change your short‐run and long‐

run analysis in part a?

 

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