Assume the US dollar depreciates against other currencies. Under the linked exchange rate system, Hong Kong pegs its nominal exchange rate to the US dollar.
1. Explain what would happen to the prices of goods and services (in terms of US dollars) in Hong Kong if domestic prices remain unchanged?
2. Explain (with the aid of an aggregate output market diagram) the short-term impact on the Hong Kong economy of the depreciation of the US dollar.
3. Analyze the possible impact on the local general price level if there is a continuing depreciation of the US dollar.
4. Assume the linked exchange rate system is abolished in Hong Kong. Explain how it would affect your prediction in part (c).