HW # 10: PROBLEM SET
The DD-AA Model: Fiscal and Monetary Policy
under Flexible and Fixed Exchange Rates
In doing the following graphical problems, closely follow the models shown in the textbook and in the class lectures. These problems should help in preparing for the final exam.
1) Using the aggregate demand curve, graphically derive the DD curve. Tell briefly what the assumptions are. Explain what you are doing and show the sequential causal chain of effects. What does the DD curve represent? What variables shift the DD curve?
2) Using money supply-money demand and the interest rate parity relationship,
derive the AA curve graphically. Tell what the assumptions are. Explain what
you are doing and show the sequential causal chain of effects. What does the
AA curve represent? What variables shift the AA curve?
3) Use the DD and the AA curves to determine equilibrium output (Y) and exchange
rate (E). In the graph, draw the XX curve to show the combinations of Y and E
for which the current account is constant. Why is the XX curve flatter than the
DD line? What happens to the current account for points above the XX curve?
For points below the XX curve?
4) Using the DD-AA model under flexible exchange rates, show (a) the effects of
monetary policy in the short-run, and (b) the effects of monetary policy in the
long-run. What accounts for the difference between the short-run and the long-
run? What are the main results?
5) Using the DD-AA model under flexible exchange rates, show (a) the effects of
fiscal policy in the short-run, and (b) the effects of fiscal policy in the long-run.
What are the main results?
6) Using money supply-money demand and the interest rate parity relationship,
show how the central bank can maintain fixed exchange rates in the face of
changes in output.
7) Using the DD-AA model under fixed exchange rates, show the effects of
monetary policy. What are the main results?
8) Using the DD-AA model under fixed exchange rates, show the effects of fiscal
policy. What are the main results?
9) Using the DD-AA model under fixed exchange rates, show the effects of a
devaluation policy. What are the main results?
10)Using money supply-money demand and the interest rate parity relationship,
show how the central bank can deal with a balance of payments crisis and capital
flight.