ECON6008: International Money & Finance, Semester 2 2020
1. Solve the model described above using Dynare. Obtain the impulse response for 10
periods to a one-time 1% shock to
(a) money supply or the domestic interest-rate shock (“m;t);
(b) preference (“g;t);
(c) labor supply (s;t);
(d) foreign output (“y
Analyze (i.e. explain the dynamics) and plot the eect of each of these shocks to
domestic output (ybt), consumption (bct), interest rate (bit), in
ation (bt), domestic-currency
nominal depreciation (eb
), and the “shocked” variable (e.g. if it’s a foreign output shock,
). Plot these six variables in one 3×2 gure or plot (with 3 rows and 2
columns). Relate your analysis to what you have learned in the rst half of the course
(the qualitative AA-DD model). For the money supply or the domestic interest-rate shock,
do you observe an overshooting of the nominal exchange rate?
[Extra points: plot the evolution of the level of nominal exchange rate and the current
account in a separate gure and explain the dynamics.]
2. COVID-19 pandemic and monetary and exchange-rate policies.
Let’s analyze the economic impact of the COVID-19 pandemic using this model, with
several dierent assumptions on the central bank’s monetary and exchange-rate policies.
Here, the COVID-19 pandemic “shocks” are proxied by a combination of negative labor
supply and negative preference shocks. The preference (or consumer-spending) shock in
the model is a type of demand shock that in
uences household intertemporal consumptionsaving decisions. A negative preference shock thus serves as a proxy for a reduction in
aggregate demand during the pandemic, e.g. due to lost labor income or an increase in
household income uncertainty which leads to a precautionary saving behaviour. A negative
labor supply shock captures an aggregate supply reduction due to supply-chain disruptions
and large-scale social and economic restrictions (lockdowns).
In particular, assume that the economy starts at period 0 (2019.Q4) at the steady
state. Assume that the pandemic “shocks” occur for 4 periods or quarters, from periods
1-4 (2020.Q1-2020.Q4) with the following magnitudes:
Labor supply (s;t) 5% 7% 3% 2%
Preference (“g;t) 3% 3% 2%
There are positive labor supply and preference shocks in period 4, perhaps in response to
the expectations that an eective COVID-19 vaccine is imminent and about to be approved
and rolled out to the public.
(a) Analyze the eect of these pandemic shocks under the current policy rule with i =
0:75, = 1:9, y = 0:08, y = 0:67, and e = 0. Plot the responses of ybt
in one (3×2) gure. Explain their dynamics. In another (2×1) gure, plot the
evolution of exogenous labor supply variable ^”s;t and consumer preference variable gbt
Is this combination of shocks a realistic representation of the COVID-19 pandemic
(b) In the model above, we assume a fully-
oating) exchange rate regime. Suppose that the central bank also directly intervenes in the foreign exchange market, i.e.
it’s operating under a managed
oating exchange rate. This policy can be analyzed
within our model by assuming that
e = 0:65 > 0
The rest of policy rule coecients are unchanged. Analyze the eect of the pandemic
shocks under this new assumption, in comparison to the eect in part (a). Plot
the responses of ybt
in one (3×2) gure. Is this policy more eective in
terms of mitigating the eect of the pandemic shocks on ybt
, and eb
(c) Now assume that the central bank is operating under a xed exchange-rate regime.
Specically, the monetary policy rule in equation (11) is replaced with the following
t = 0
This policy rule eectively (and credibly) xes the nominal exchange rate at a speci-
ed level. Redo questions 2(a). Your answer and analysis should be in comparison
oating exchange-rate regime (both when e = 0 and e = 0:65).
[Notes: (i) Dynare does not plot the impulse response of a variable if that variable is
always constant (zero deviation from the steady state), (ii) since the foreign-debt holding,
bat, enters the UIP condition in equation (8), you will generally not nd bit = bi
t under the
xed-exchange rate regime, unless = 0)].