Aggregate demand in an open economy with a fixed exchange rate. Help me with my equation? ?
I’ve been asked…
Consider the specification of the aggregate demand relation in an open economy with fixed exchange rate as follows:
Y = C(Y -T) + I(Y,i – ei) +G + NX (Y,Yf, EP/Pf)
Where: Y = income, I = investment, i = interest rate, ei = expected inflation, G – govt spending, NX = net exports, E = exchange rate (fixed), P = Price level, Yf = foreign income, Pf = Foreign prices
Can are asked what would happen…
i.An increase in the foreign price level. Explain in words. Draw graph if you think that is necessary.
Would the LM curve shift to the right??
ii.An increase in expected inflation. Explain in words. Draw graph if you think that is necessary.
iii.Discuss the following: ‘Why do economists say inflation is bad? High inflation abroad and high expected inflation at home, both increase output?’
I’m going to say that its because they create all sorts of other negatives such as reduced confidence and investment…
