1
a.
i. Aggregate demand in Songland will increase.
The depreciation of Songland’s currency makes Songland’s exports cheaper and more competitive internationally, increasing net exports and aggregate demand.
ii. Employment will increase.
As aggregate demand rises, output expands, and businesses hire more workers to meet increased production demands.
b.
i. Songland’s central bank should sell euros.
By selling euros and buying Songland dollars, the bank increases the demand for Songland dollars, appreciating Songland’s currency.
ii. The central bank can achieve the same result by conducting a contractionary open-market operation (selling domestic bonds).
This reduces the money supply, increases domestic interest rates, attracts foreign investors, and thus appreciates the Songland dollar.
2
a.
Full employment ADAS
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GDP
PL
SRAS
AD
LRAS
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PL1
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b.
S+ Loanable funds
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Real interest rate
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D
S’
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c.
i. Interest-sensitive expenditures will increase due to lower interest rates, making investments cheaper.
ii. Economic growth Economic growth increases because lower interest rates stimulate investment spending, thus increasing capital stock and future productivity.
d.
i. Demand for the euro increases because higher interest rates in the Eurozone attract capital inflows.
ii. The euro appreciates relative to the dollar due to increased demand for euros.
e.
The appreciation of the euro means depreciation of the USD, increasing U.S. exports and reducing imports. Thus, the U.S. current account balance moves into a surplus.
3
a.
UR+ Philips Curve 1 1
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b.
i. increases by $100 billion
ii. Total increase in loans = (initial excess reserves created) × money multiplier = 400 billion.
iii. Money supply increases by the full multiplier effect on monetary base, thus increases by $400 billion.
c.
S+ Money market
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D
Nominal interest rate
Quantity of money
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S2
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d.
e.
Due to lower nominal interest rates, international investors move capital out of the country, causing currency to depreciate.
f.
Net exports will increase. Depreciation makes the country’s goods cheaper abroad, stimulating exports and reducing imports, thus improving net exports.