ECON 356 Lecture Notes - Lecture 6: Business Cycle, Money Supply

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26 Jul 2017
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Assume two countries, d and f, operating under fixed exchange rates. Except for the explicit assumption that one country is small", both countries are taken to be large"; assumed to be about equal size. These questions are designed to illustrate a virtue of the quantity theory of money: namely its proportionality. Since e = pf/pd, everything follows from the proportionality of the changes in price levels with respect to shocks. If y1 increases by 10%, then p falls by 10%, everything else constant. If y2 increases by 10% then v increases by 10%, and p rises by 10%, and so on. The adjustment in prices to maintain e is accomplished through the gold flow. Successful sterilization, or a small country assumption, block the movement of one of pd or pf. Each problem can be worked out pretty exactly on the graph if the incomes of the two large countries are about the same.

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