1. Keynes and Churchill. Prior to World War I, each of the European coun- tries
ID: 1124169 • Letter: 1
Question
1. Keynes and Churchill. Prior to World War I, each of the European coun- tries fixed their currencies to the price of gold. However, during World War I (a) Suppose that over the course of World WarI, inflation is much higher in the UK than the rest of Europe. If the UK decided to go back on the exchange rate at the pre-war parity, how would this affect the real exchange rate. nent and balanced trade, but then decides to go back on the gold standard at the pre-war exchange rate. Use an IS-LM-UIP diagram to show the effects of the change in the exchange rate: i. What happens to net exports? ii. How does the change in net exports effect output? Is the fol lower country still at potential output? If not, is the output gap positive or negative?Explanation / Answer
(a) Inflation is higher in UK than the rest of Europe
More gold is required to but a unit of something in UK comparatively. UK goods increase in price quicker than European goods. The real exchange rate will get disturbed because of the inflation, the same currency can't be used in all the places.
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