John Jay College of Criminal Justice
Department of Economics
ECO 220 – Macroeconomics – Fall 2019
Assignment 10 – Extra Credit
Balance of Payment Crisis, Foreign Exchange Rate and Inflation
1. Explain why developing countries (that do not issue international currencies)
could face balance of payments crisis (“external constraint”)
2. Considering the following “markup price equation” for a developing country,
explain why an increase in the exchange rate � (“currency devaluation”) causes an
increase in the domestic price level � and, consequently, a reduction in the real
wage
#
$
� = 1 + � �� + ��+�
where � = –
.
and � = 0
.
are labor-output and import-ouput ratios, respectively
(these coefficients are assumed as given); � is an stable markup, � is the nominal
wage and �+ is the international price level.
See Goodwin et al (2019) Chapter 14, and Bastian and Setterfield (2017) “Nominal
exchange rate shocks and inflation in an open economy: towards a structuralist inflation
targeting agenda”
https://ideas.repec.org/p/new/wpaper/1720.html
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