Poland and Estonia are different in that Estonia fixes its currency to the German DM, and Poland has a flexible exchange rate. Use IS-LM-FX model to discuss how the effects of the shock differ on the two countries ’levels of output, exchange rate, and trade balance. Is there
a benefit to having a flexible exchange rate or pegging? Explain carefully.
A. Poland and Estonia both are experiencing a fall in foreign demand for their goods, due to
the recession beginning in Germany (It is assumed that German interest rate is constant)
B. Poland and Estonia both are experiencing an increase in money demand, due to the unstable financial market.