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depreciation of the currency

1.Using the given ISLM model below, complete the policy statement to explain what would happen to foreign reserves at the central bank (or the FED), when a contractionary monetary policy is instituted under a fixed exchange rate system.

***ISLM Model attached as file****

The Policy statement:

1.------------------------------- monetary policy shifts the LM-curve to the 2.---------------, so the domestic interest rate 3.-------------------- while the level of output 4.-------------------------. Due to the 5.------------------- interest rate, there is an 6. ------------------ of funds and the domestic currency begins to 7.------------------------------.

Under a fixed exchange rate system, however, the central bank will have to intervene and so will have to trade domestic currencies for foreign currencies, thereby 8.------------------------- the supply of money. This 9.----------------------------- the LM-curve back to the right, and the foreign reserve holdings of the central bank will 10.------------------------.

2. Suppose the value of the UNIT in terms of the dollar is:
50 on October 12 , and 44 on October 17. By how much (in percentage terms) has the UNIT appreciated or depreciated against the dollar?

3. Suppose the Value of the UNIT in terms of the dollar is 40 on October 12 and 45 on October 17. By how much (in percentage terms) has the UNIT appreciated or depreciated against the dollar?

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1.CONTRACTIONARY monetary policy shifts the LM-curve to the 2.LEFT, so the domestic interest rate 3.RISES while the level of output 4.FALLS. Due to the 5.HIGHER interest rate, there is an 6. INFLOW of funds and the domestic currency begins to 7.APPRECIATE.

Under a fixed exchange ...

Solution Summary

Depreciation of the currency is portrayed.

$2.19