Assume That Initially, the Risk Premium, ρ = 0 and That

question 38

Essay

Assume that initially, the risk premium, ρ = 0 and that the domestic and foreign interest rates are given by R = .06, R* = .05. Suppose that the risk premium depends linearly on the difference between domestic government debt, B, and domestic assets of the central bank, A, i.e.,
ρ = Find the new domestic interest rate if a sterilized purchase of foreign assets adjusts A s.t.
(a) B - A = -.01/ (b) B - A = .01/ (c) B - A = .03/

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