Consider an open economy with flexible exchange rates. Let UIP stand for the uncovered interest parity condition.
a. In an IS-LMâUIP diagram, such as Figure 19-2, show the effect of an increase in foreign output, Y*, on domestic output (Y) and the exchange rate (E), when the domestic central bank leaves the policy interest rate unchanged. Explain in words.
b. In an IS-LMâUIP diagram, show the effect of an increase in the foreign interest rate, i*, on domestic output (Y) and the exchange rate (E), when the domestic central bank leaves the policy interest rate unchanged. Explain in words.
Figure 19-2:
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