Macroeconomics open economy

Question

Suppose the exchange rate between the British pound and the U.S. dollar is £1 = $1.50.

a.) Draw a graph showing the demand and supply of pounds for dollars. (y-axis: price of pounds, dollars per pound, x-axis: quantity of pounds)

b.) If the Bank of England implements a contractionary monetary policy, explain what will happen to the exchange rate between the pound and the dollar and show this on a graph. Has the dollar appreciated or depreciated relative to the pound? Explain.

c.) If the U.S. government implements an expansionary fiscal policy, explain what will happen to the exchange rate between the pound and the dollar and show this on a graph. Has the dollar appreciated or depreciated relative to the pound? Explain.

Hint: Due to the given policies in part b and c, first interest rates are going to change.

Answer 1