Assume that initially, the risk premium, ? = 0 and that the domestic and foreign interest rates are given by R = .06, R* = .05
Suppose that the risk premium depends linearly on the difference between domestic government debt, B, and domestic assets of the central bank, A, i.e., ? = Find the new domestic interest rate if a sterilized purchase of foreign assets adjusts A s.t. (a) B - A = -.01/ (b) B - A = .01/ (c) B - A = .03/
(a) R = .05 + .01 + (-.01 ) = .05
(b) R = .05 + .01 + (.01 ) = .07
(c) R = .05 + .01 + (.03 ) = .09
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