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In the 3-sector model, analyzing the effect of an economic shock is most complex in the Foreign Exchange sector because 3 variables must be analyzed separately and then sometimes jointly. A change in the RDGP primarily affects imports whereas a change in PI mostly affects exports. A change in R influences foreign capital flow into or out of the nations economy. The foreign exchange effects can be analyzed graphically as in Marthinsen; however, both the supply and demand curves usually shift which can be confusing. You may find it easier to determine whether the domestic currency will appreciate or depreciate directly by-passing the graphical analysis. Problems 1 through 3 take this approach.
For each choice in parentheses, highlight the correct answer.
A rise in RGDP tends to (increase or decrease) imports which then (increases or decreases)NE and, this in turn, (appreciates, depreciates) the domestic currency.
A rise in PI leads to a (increase or decrease) in exports which (increases or decreases) NE. This then leads to (appreciation or depreciation) of the domestic currency.
If R rises, capital flows (into or out of) the nation which causes an (appreciation or depreciation) of the domestic currency.
Capital markets have high mobility if foreign capital tends to flow rapidly into the nation when real risk-free interest rates rise slightly above the rates available in other nations. With high capital mobility, R tends to be (more or less) influential on exchange rates than PI and RGDP.
For problems 5 through 15, assume the central bank engages in aggressive open market purchases in an effort to stimulate the domestic economy. The nation has flexible exchange rates and the central bank does not intervene in the foreign exchange markets.
Show the shift in the supply or demand for RLF by inserting a new curve. Insert arrows to show the change in R and RLF
SDRSRLF/time period
The open market purchases (increase or decrease) the supply of RLF…



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