Econ 434: International Finance and Open Economy Macroeconomics

Econ 434: International Finance and Open Economy Macroeconomics
Homework 6
Due in Class May 1, 2014
Please show your work!
Exchange Rate Crises
1. Consider the first generation crisis model without forward looking agents (they don’t anticipate
the crisis). Explain how the fiscal deficit affects the pattern over time of a) international
reserves, b) domestic interest rates, c) the local price level, and d) the exchange rate. Use time
graphs and the relevant equations in your answer.
2. Now consider the first generation crisis model with forward looking agents (they do anticipate
the crisis). Explain how the fiscal deficit affects the pattern over time of a) international
reserves, b) domestic interest rates, c) the local price level, and d) the exchange rate. Use time
graphs and the relevant equations in your answer.
3. Banking crisis often occur at roughly the same time as exchange rate crises. Explain how
banking crises can cause an exchange rate crisis and how an exchange rate crisis can cause a
banking crisis.
4. Sovereign defaults often occur during an exchange rate crisis. Elaborate on how an exchange
rate crisis can lead to a sovereign default.
5. How does the second generation model of exchange rate crises differ from a first generation
model of exchange rate crises?