ECON 3023 International Finance
Semester 2, 2024-2025
Assignment 2
1. Consider the following DD-AA model. Consumption is given by $C = (1 - s)Y$.
The current account balance is given by $CA = aE - mY$. The good market
equilibrium condition is $Y = C + I + G + CA$. The interest parity condition
$R = R^* + (E^e - E)/E$ holds. The equilibrium condition of the money market
is $M^s/P = 2Y - 2000R$. Suppose initially the $I = G = 100, s = 0.3, m =
0.2, a = 200, R = 0.05$. The initial exchange rate is $E = 1$.
a. Assume that the central bank can hold the exchange rate $E$ constant.
What is the effect of an increase in government spending $G$ by 50 on
output $Y$?
b. How will the fiscal expansion affect the $CA$?
c. Find the change in real money supply $M^s/P$ that can keep the exchange
rate from changing.
d. What will happen if the central bank does not change the money supply?
Will the fiscal expansion become more or less potent?
2. Using the DD-AA model, analyze the output and balance of payments effects
of an import tariff under fixed exchange rates. How would the tariff affect other
country? Discuss what would happen if all countries in the world
simultaneously try to improve employment and the balance of payments by
