This is a a paper that is focusing on the using three equation model to show new medium-run equilibrium. The paper also provides a possible plan structure to use in writing the assignment.
Using three equation model to show new medium-run equilibrium
(a) Question –
Use the three equation model to show the new medium-run equilibrium of a member of a common currency area following a permanent negative demand shock. How would medium run equilibrium output, real exchange rate and government budget balance differ from the case of a flexible exchange rate economy facing a similar shock? [40 marks]
Use Textbook Macroeconomics – Carlin and Soskice – Chapter 12 (page 448 panel (depreciation))
· The best answers to part (a) will demonstrate accurate graphical analysis, fluent mastery of theoretical concepts, ability to analyze a model under different assumptions, ability to coherently explain and also interpret a model and use it to compare different circumstances, and ability to clearly summarize conclusions:
Plan: A possible structure
Comparison of a permanent negative demand shock on: common currency area & flexible exchange rate.
Firstly, define CCA
SECONDLY, WHAT WOULD HAPPEN IF THERE WERE A NEGATIVE DEMAND SHOCK
Thirdly, effect on output
Fourthly, real exchange rate
Also, government budget balance
What is a flexible exchange rate economy
What would happen in a flexible exchange rate economy
Difference between the effect on C.C.A and flexible exchange rate
The common currency area is an economic region where countries share the same nominal currency and also share the same independent supernatural body (ECB) who’s has independent control of the monetary policy.
These independent bodies use the monetary policy to affect aggregate demand which in turn impacts the exchange rate. If a negative demand shock in a Common Currency Area (CCA) there would be a decrease in output below equilibrium
· A flexible exchange-rate system is a monetary system that allows the exchange rate to be determined by supply and demand. Every currency area must decide what type of exchange rate arrangement to maintain.