The complete lung-run model for exchange rate determination

Reference no: EM13378667

The complete lung-run model for exchange rate determination posits that changes in the nominal interest rate also affect the exchange rate (E). Recall that the complete model combines the QTM, PPP and the Fisher effect. The simple lung-run version of the same model leaves out the effects of changes in nominal interest rate . Suppose the following scenario: ^Yus=^Yeu=0% . From 2011 to 2012 the FED sets a stable ^Mus=3%, but in 2013 the FED decides to reduce the rate of growth of the money supply by permanently setting ^Mus=1%. Trace out the lung-run effects in both models of a lower rate of growth of the money supply in the US in terms of M, M/P, i, P, and E. Recall that in the long run P is fully flexible and i only changes when the nominal anchor changes. [Hint: Your are supposed to do a similar analysis to what we have done in class, but now considering a monetary contraction in the US economy. You should have 8 graphs in total: 4 for the simple model plus 4 for the general model.]

Reference no: EM13378667

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