RX Curve

Question 1

What is the RX curve?

Answer 1

RX curve= interest rate-exchange rate curve.

It shows the central bank’s best real rate response, taking into account forex market reactions.

Question 2

What do central bank decisions reflect?

Answer 2

• Forward-looking forex market behaviour.

- Effect of q on y.

Question 3

RX and IS curves

Answer 3

RX and IS curve interactions determine how the central bank will adjust to a shock.

The central bank will adjust along the RX curve, so the IS curve moves along it.

Question 4

Write down the RX curve equation.

Answer 4

yt - ye =

a + b/1- lambda) (rt-1 - r*

Question 5

RX curve characteristics

Answer 5

RX curves go through the intersection of r* and ye.

RX curves shift if the world interest rate or equilibrium changes.

Question 6

What changes the slope of the RX curve?

Answer 6

1. Interest rate sensitivity a, and exchange rate sensitivity b.
2. Central bank’s preferences B (inflation/unemployment aversion).
3. Phillips Curve slope alpha.

RX is flatter if a and b are higher, and if α and β are lower.

Question 7

What does a flatter RX curve mean?

Answer 7

A smaller interest rate response change is needed to generate a given change in output