4. (Cooperation in ER systems) Suppose Latvia and Denmark both peg their exchange rates to...
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4. (Cooperation in ER systems) Suppose Latvia and Denmark both peg their exchange rates to the Euro. (a) Denmark is in an equilibrium in which Y=Y, where Y is the target output level. Latvia is suffering from a negative demand shock that shifts its IS curve to the left, putting its equilibrium output (Y) below its target output (Y~). Use an IS-LM figure for each country to show this situation. (b) Suppose Latvia chooses to devaluate its exchange rate against the Euro (i.e., to adjust the level of the exchange rate at which they peg). Show the effect on your figures from part (a) (c) How is Denmark affected by Latvia's choice? Explain
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