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Consider two countries, Home and Foreign, during the international gold standard. The central bank in each country offers a fixed currency price in...
Consider two countries, Home and Foreign, during the international gold standard. The central bank in each country offers a fixed currency price in terms of gold (gold parity) and does not adjust it. This implies that the nominal exchange rate between Home and Foreign is fixed. Let the Home and Foreign Price levels be P and P∗, respectively, and consider them completely flexible.
a. (3 Points) Suppose the Foreign central bank increases its money sup- ply. What is the immediate effect of a foreign money supply increase on Home's real exchange rate?
b. (3 Points) What does the immediate real exchange rate response im- ply for Home's current account balance?
c. (4 Points) Explain how the resulting gold shipments will restore the current account balance between Home and Foreign under the price- specie-flow mechanism.
