INTERNATIONAL MACRO FINANCE
HOMEWORK 4
Exercise 1 The Mundel-Fleming-Dornbusch model. Consider the model we
habe been working in class
it+1 = i⇤t+1 + set+1
mdt
= pt + y t
✏t = st + p⇤t
st
⌘it+1
pt
ytd = ȳ + (st + p⇤ pt ✏¯)
pt+1 pt =
ytd ȳ + (st+1 st )
(1) Briefly explain each variable and each equation.
(2) Identify the control(s) and state(s) variables of the model.
(3) Reduce the model in thw two following equations:
✏t+1
(✏t
✏¯)
st
(1
)
( ✏¯ + mt )
✏t
⌘
⌘
⌘
by normalizing i⇤ = p⇤ = ȳ = 0.
Is ✏ a control or a state variable? why?
Find the steady state of the model. Explain it.
Plot the solution of the model in a phase diagram.
Modify the equation
st+1
(4)
(5)
(6)
(7)
✏t =
st =
ytd = ȳ + (st + p⇤
pt
✏¯) + g
where g is fiscal expenditure (here no budget concerns!). Analyze a permanent decrease in g in the phase diagram. Plot the dynamics of the nominal
and the real exchange rate. If you wish you can add the computer solutions.
Explain your results.
Question 1: Evidence. Describe the evidence for the overshooting of the nominal
exchange rate (Rogoff article).
Question 2: Overshooting/Undershooting of the real exchange rate. Describe the long run equilibrium value of the real exchange rate after a fiscal policy
expansion.
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