Monetary Model

Question 1

Why Monetary Model is useful?

Answer 1

1. good benchmark
2. captures long run trend
3. easy to understand, simple

Question 2

What are the building blocks for Monetary Model?

Answer 2

1. Money demand is determined price level and income ( Md= k P y , where k>0)
2. PPP holds, implies P=SP*
3. AS is vertical, implies Prices are flexible

Question 3

What is a sterilization?

Answer 3

Process of neutralizing effect of BoP deficit (surplus) by creating (retiring) enough DC to offset fall in FX is known as sterilization
Skepticism about whether sterilization can work, especially in the long run.
Sterilization could lead to a vicious cycle and can only last until fx reserves run out

Question 4

What are the assumptions for Monetary model?

Answer 4

Vertical Aggregate Supply Curve
Stable Demand For Money
Purchasing Power Parity