**CARMANIA — A Large Open Economy With Flexible Exchange rate**

** Real Sector**

C = 2.400 + 0.90 (Y-T) Consumption function, where MPC =0.9; Y=income;T=Taxes

I=12.000-100r, Investment function, where r = interest rate

G = 20.000 ... Government spending (exogenous)

X = 5,000+500 e... Export function, where enominal exchange rate=$/foreign currency

M=4,000-100 e+0.1Y... Import function

T=6.000

** Monetary Sector**

Ms = 70,000 Money supply equation, where Ms = Money supply

Md = 0.50 Y-I 00 r... Money demand equation, where Md=Money demand

(b) Use the following equation for monetary sector equilibrium and derive the LM equation or Caminia's Y in terms of r.

Ms = Md... Monetary Sector equilibrium condition

** Foreign Sector**

Current Account Balance CAB = X-M=(5,000+500e)-(4,000-100e+0.IY)

Capital Account Balance I(AB = 500 r + 200e

(c) Use the following Balance of Payments equilibrium condition and derive the BOP equation for Caminia's Yin terms of r and e. Notice the negative sign on KAB.

CAB = -KAB ... BOP equilibrium condition

** Nominal Exchange rate = e = Unit of Domestic Currency / Unit of Foreign Currency **

** Interest rate Parity: i = i* + (e^e — e) / e **

** R = (P)/ (e x P*) = Real Exchange rate **

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