Exercise 9.10

Exchange-Rate Policy and GDP in Terms of Tradables

⬅ Return

Problem

Take a look at the two bottom panels of Figure 9.12 showing the behavior of the trade-balance-to-output ratio and the debt-to-output ratio predicted by the model of Section 9.1 during an external crisis under a currency peg and under the optimal exchange-rate policy. Note that these responses differ across the two exchange-rate regimes, even though the responses of the levels of the trade balance and the external debt are identical across exchange-rate policies, due to the assumption \(\sigma=1/\xi\). Of course, all differences must be due to the fact that output (measured in terms of tradables) behaves differently across exchange-rate regimes. Explain analytically the nature of these differences. Consider in particular the cases \(\xi=1\) and \(\xi>1\) under the maintained assumption \(\sigma=1/\xi\).

Answer

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