Answer to Question #174204 in Macroeconomics for June

Question

Assume Country X’s economy is currently at full employment.

(a) If country X’s net exports decrease, what will happen to the price level in Country X? Explain.

(b) Draw a correctly labeled graph of the money market, and show the effect of the change in the price level identified in part (a) on the nominal interest rate.

(c) Based on your answer to part (b), what will happen to the price of previously issued bonds?

(d) Identify an open market operation that country X’s central bank can use to offset the change in the nominal interest rate from part (b).

Answer 1

(a) The price level will increase. This is because when the exchange rate is high, the relative price of goods at home country is higher than the relative price of goods abroad.

(b)

when the money demand shifts from MD₁ to MD₂ the nominal rate of interest will rise from r₁ to r₂

(c) The price of previously issued bonds will decline. When the nominal interest rate rise, the price of bonds decline .

(d)The central bank will apply the expansionary monetary policy. This is whereby the trading desk will purchase government securities and the central bank will deposit funds into bank account of sellers thereby increasing the amount of funds that banks have available to lend.