Assume That a Large Open Economy with a Floating Exchange

question 48

Essay

Assume that a large open economy with a floating exchange rate is described in the short run by the equations:
C = 0.5(Y - T)
T = 1,000
I = 1,500 - 250r
G = 1,500
NX = 1,000 - 250e
C + I + G + NX = Y
M/P = 0.5Y - 500r
M = 1,000
CF = 500 - 250r
NX = CF
The last two equations specify that CF, net capital outflow, decreases with r, the interest rate, and that NX, the net exports, is equal to net capital outflow. NX is also related to the exchange rate, e, and falls when e appreciates. The price level (P) is fixed at 1.0.
Calculate short-run equilibrium values of Y, r, C, I, CF, NX, e, private saving, public saving, and foreign saving. Foreign saving is defined here as minus NX. Check your work by ensuring that C + I + G = Y and private saving plus public saving plus foreign saving equals domestic investment. (Hint: As in the appendix to textbook Chapter 13, form the IS curve from C + I + G + NX = Y, and then substitute CF for NX to get C + I + G + CF = Y. Combine with the LM curve and solve for Y, r, and CF and then use NX = CF to get NX and the equation relating NX to e to get e.)

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