Assume That the LM Curve for a Small Open Economy

question 11

Essay

Assume that the LM curve for a small open economy with a fixed exchange rate is given by Y = 200r - 200 + 2(M/P). This IS curve is given by Y = 400 + 3G - 2T + 3NX - 200r. The function for the net exports is NX = 200 - 100e, where e is the exchange rate. The price level is fixed at 1.0, the world interest rate is r* = 2.0 percent, and the exchange rate is initially 1.0.
a. If M = 100, G = 100, and T = 100, solve for the equilibrium short-run values of Y and NX. Is the initially given exchange rate equal to the equilibrium exchange rate?
b. If the Fed buys bonds in order to raise the money supply, will equilibrium Y increase?

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