04 Jun Question 1. For each of the following situations, use the IS-LM-FX model
Question
1. For each of the following situations, use the IS-LM-FX model to illustrate the effects of the temporary
shock and the policy response. (Note: Assume the government responds by using monetary
policy to stabilize output.) For each case, state the effect of the shock on the following domestic
variables (increase, decrease, no change, or ambiguous): Y , i, E, C, I, T B. Assume a flexible
exchange rate.
a All else equal, there is an increase in the foreign interest rate. [10 points]
b All else equal, the real demand of money falls. [10 points]
2. For each of the following situations, use the IS-LM-FX model to illustrate the effects of the shock.
For each case, state the effect of the shock on the following domestic variables (increase, decrease,
no change, or ambiguous): Y , i, E, C, I, T B. Assume a fixed exchange rate.
a All else equal, the real demand of money falls. [10 points]
b All else equal, there is a decrease in taxes. [10 points]
3. The Chinese Renminbi was pegged to the USD before July 2005. Using the IS-LM-FX model for
Home (China) and Foreign (US), illustrate how a decrease in G in China before July 2005 affected
the following Chinese variables (increase, decrease, no change, or ambiguous): Y , i, E, C, I, T B.
Do not forget to use a diagram to support your answer. For the purposes of this problem assume
international capital mobility.
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