• Home
  • Textbooks
  • International Economics: Theory and Policy
  • Output and the Exchange Rate in the Short Run

International Economics: Theory and Policy

Paul Krugman, Maurice Obstfeld och Marc J. Melitz

Chapter 17

Output and the Exchange Rate in the Short Run - all with Video Answers

Educators

Chapter Questions

00:23

Problem 1

How does the $D D$ schedule shift if there is a decline in investment demand?

Jennifer Stoner
Jennifer Stoner
Numerade Educator
02:53

Problem 2

Suppose the government imposes a tariff on all imports. Use the $D D-A A$ model to analyze the effects this measure would have on the economy. Analyze both temporary and permanent tariffs.

Yang Su
Yang Su
Numerade Educator
00:47

Problem 3

In 2015 , the Canadian government intended to adopt a balance budget act requiring the government to maintain a balanced budget at all times. Hence, if the government wishes to change government spending, it will always have to change the taxes by the same amount, that is, $\Delta G=\Delta T$. Does this law imply that the government can no longer use fiscal policy to affect employment and output? (Hint: Analyze a "balanced-budget" increase in government spending, one that is accompanied by an equal tax hike.)

Jennifer Stoner
Jennifer Stoner
Numerade Educator
01:57

Problem 4

Suppose there is a permanent fall in private aggregate demand for a country's output (a downward shift of the entire aggregate demand schedule). What is the effect on output? What government policy response would you recommend?

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator
01:15

Problem 5

Why does a temporary increase in government spending cause the current account to fall by a smaller amount than does a permanent increase in government spending?

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator
00:47

Problem 6

If a government initially has a balanced budget but then cuts taxes, it is running a deficit that it must somehow finance. Suppose people think the government will finance its deficit by printing the extra money it now needs to cover its expenditures. Would you still expect the tax cut to cause a currency appreciation?

Jennifer Stoner
Jennifer Stoner
Numerade Educator
00:58

Problem 7

You observe that a country's currency depreciates while its current account worsens. What data might you look at to decide if you are witnessing a J-curve effect? What other macroeconomic change might bring about a currency depreciation coupled with a deterioration of the current account, even if there is no J-curve?

Majid Borumand
Majid Borumand
Numerade Educator
01:26

Problem 8

A new government is elected and announces that once it is inaugurated, it will increase the money supply. Use the $D D-A A$ model to study the economy's response to this announcement.

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator
04:19

Problem 9

How would you draw the $D D-A A$ diagram when the current account's response to exchange rate changes follows a J-curve? Use this modified diagram to examine the effects of temporary and permanent changes in monetary and fiscal policy.

Haricharan Gupta
Haricharan Gupta
Numerade Educator
01:24

Problem 10

What does the Marshall-Lerner condition look like if the country whose real exchange rate changes does not start out with a current account of zero? (The Marshall-Lerner condition is derived in Appendix 2 under the "standard" assumption of an initially balanced current account.)

Jennifer Stoner
Jennifer Stoner
Numerade Educator
01:24

Problem 11

Our model takes the price level $P$ as given in the short run, but in reality the currency appreciation caused by a permanent fiscal expansion might cause $P$ to fall a bit by lowering some import prices. If $P$ can fall slightly as a result of a permanent fiscal expansion, is it still true that there are no output effects? (As above, assume an initial long-run equilibrium.)

Lucas Finney
Lucas Finney
Numerade Educator
00:44

Problem 12

Suppose interest parity does not hold exactly, but the true relationship is $R=R^{*}+\left(E^{e}-E\right) / E+\rho$, where $\rho$ is a term measuring the differential riskiness of domestic versus foreign deposits. Suppose a permanent rise in domestic government spending, by creating the prospect of future government deficits, also raises $\rho$, that is, makes domestic currency deposits more risky. Evaluate the policy's output effects in this situation.

Jennifer Stoner
Jennifer Stoner
Numerade Educator
00:19

Problem 13

If an economy does not start out at full employment, is it still true that a permanent change in fiscal policy has no current effect on output?

Jennifer Stoner
Jennifer Stoner
Numerade Educator
06:37

Problem 14

Consider the following linear version of the $A A-D D$ model in the text: Consumption is given by $C=(1-s) Y$ and the current account balance is given by $C A=a E-m Y$. (In macroeconomics textbooks, $s$ is sometimes referred to as the marginal propensity to save and $m$ is called the marginal propensity to import.) Then the condition of equilibrium in the goods market is $Y=C+I+G+C A=(1-s) Y+I+G+a E-m Y$. We will write the condition of money market equilibrium as $M^{s} / P=b Y-d R$. On the assumption that the central bank can hold both the interest rate $R$ and the exchange rate $E$ constant, and assuming that investment $I$ also is constant, what is the effect of an increase in government spending $G$ on output $Y$ ? (This number is often called the open-economy government spending multiplier, but as you can see it is relevant only under strict conditions.) Explain your result intuitively.

Manasvee Singh
Manasvee Singh
Numerade Educator
02:00

Problem 15

See if you can retrace the steps in the five-step argument on page 485 to show that a permanent fiscal expansion cannot cause output to fall.

David Gagnon
David Gagnon
Numerade Educator
00:35

Problem 16

The chapter's discussion of "Inflation Bias and Other Problems of Policy Formulation" suggests (p. 481 , paragraph 4) that there may not really be any such thing as a permanent fiscal expansion. What do you think? How would these considerations affect the exchange rate and output effects of fiscal policy? Do you see any parallels with this chapter's discussion of the longer-run impact of current account imbalances?

Jennifer Stoner
Jennifer Stoner
Numerade Educator
01:10

Problem 17

If you compare low-inflation economies with economies in which inflation is high and very volatile, how might you expect the degree of exchange rate pass-through to differ, and why?

Jennifer Stoner
Jennifer Stoner
Numerade Educator
00:52

Problem 18

In November 2015, the Government of India formulated a policy for according preference to the government procurement of electronic goods that are manufactured domestically. According to the news reports, this campaign, referred to as "Make in India," promotes economic strength and a more robust standing in the global market"
Do you think the Indian government spending constrained by this national preference policy has a bigger effect on Indian output than unconstrained Indian government spending? What could happen if this policy is extended to the over all government spending?

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator
01:53

Problem 19

Return to problem 14 and notice that, to complete the model described there, we must add the interest parity conditions. Observe also that if $Y^{f}$ is the fullemployment output level, then the long-run expected exchange rate, $E^{e}$, satisfies the equation: $Y^{f}=\left(a E^{e}+I+G\right) /(s+m)$. (We are again taking investment $I$ as given.) Using these equations, demonstrate algebraically that if the economy starts at full employment with $R=R^{*}$, an increase in $G$ has no effect on output. What is the effect on the exchange rate? How does the exchange rate change depend on $a$, and why?

Breanna Ollech
Breanna Ollech
Numerade Educator
01:53

Problem 20

We can express a linear approximation to the interest parity condition (accurate for small exchange rate changes) as: $R=R^{*}+\left(E^{e}-E\right) / E^{e}$. Adding this to the model of problems 14 and 19 , solve for $Y$ as a function of $G$. What is the government spending multiplier for temporary changes in $G$ (those that do not alter $E^{e}$ )? How does your answer depend on the parameters $a, b$, and $d$, and why?

Breanna Ollech
Breanna Ollech
Numerade Educator