Problem
Consider two identical countries in our standard overlapping generations model. In each country, the population of every generation is 100, and each young person wants money balances worth 10 goods. There are $400 of country a (Germany) and 100 euros of country b money. The exchange rate is fixed at 1. There no foreign-currency controls, and the monetary authorities do no cooperate. Each country is willing to raise up to 500 goods in taxes on their old citizens to defend the exchange rate.
a. What is the value in goods of a dollar? Of a pound?
b. Find the value of a dollar if people abandon use of the pound and the value of a pound if people abandon use of a dollar.
c. To be free from a speculative attack, a country's commitment to defend the exchange rate must be suffiecient to purchase all of its currency if it is offered for foreign exchange. Which of these two countries is subject to a speculative attack? (Hint: use the answerings of part b to answer)
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.