Econ 182 Final
the IMF agreement forced the us to exchange gold for dollars at what price
$35/ounce
us macroeconomic policies in the late
1960s helped cause the breakdown of the bretton woods system by early 1973
under purchasing power parity
E$/E = PUS/PE.
90. what are the predictions for the long run equilibrium of the monetary approach
E$/E = Pus/Pe Pus = Mus/L(R,Y) Pe = Me/L(R,Y) a rise in the interest rate R$ lowers us money demand L(R,Y) thereby causing a rise in the us price level and a proportional depreciation against the euro a rise in us output Yus raises real US money demand leading to a fall in the long run US price level and a n appreciation of the dollar against the euro
37. discuss the effects of a rise in the interest rate paid by euro deposits on the exchange rate
If we make the unrealistic assumption that the expected exchange rate will not change, then a rise in the interest rate paid by euro deposits causes the dollar to depreciate. however, if the expected exchange rate were to rise, then the current exchange rate would also rise
77. explain purchasing power parity
PPP states that the exchange rate between two countries' currencies equals the ratio of the countries' price levels. a fall in a currency's domestic purchasing power will be associated with a proportional currency depreciation in the forex market and vice versa. Pus = E x PE
89. explain why exchange rate model based on PPP is a long run theory
PPP theory is a monetary approach to the exchange rate. it is a long run theory because it does not allow for rigidities. It assumes that prices can adjust right away to maintain full employment as well as PPP
when all variables start out at their long run equilibrium levels, the most important determinant of long run swings in nominal exchange rates
a change in relative inflation rates
the current account surplus is
a decreasing function of disposable income and an increasing function of the real exchange rate
under sticky prices a fall in the money supply
a fall in the money supply raises the interest rate to preserve money market equilibrium
the alteration of exchange rates to move the economy to internal and external balance may lead to all except
a guaranteed unilateral improvement in economic wealth
an increase in the world relative demand for US output causes
a long run real appreciation of the dollar against the euro
which of the following is not a result of a permanent fall in foreign demand on one country's exports under floating exchange rate
a raised level of unemployment
in order to bring about a real depreciation of the dollar, the us can hope for
a rise in foreign price levels or a fall in the dollar's nominal value in terms of foreign currencies
what is a foreign exchange swap
a spot sale of a currency combined with a forward repurchase of the currency
93. describe the chain of events leading to exchange rate determination for the following cases: a. an increase in US money supply b. increase in growth rate of US money supply c. increase in world relative demand for US products d. increase in relative US output supply
a. Pus rise in proportion to the money supply; all dollar prices will rise b. inflation rate, dollar interest rate, Pus, E, rises in proportion to Pus c. E falls and q does as well d. dollar depreciates, lowers relative price of us output, rise in q,
the case of new zealand, described in the text, is concerned with the country's
ability to sustain current account deficits
the case of new zealand, concludes that a country's current account deficits are not sustainable if a country's
ability to sustain current account deficits is questionable
78. discuss the differences between absolute and relative PPP
absolute PPP states that the exchange rate between two currencies equals the ratio of their price levels. RElative PPP states that the percentage change in the exchange rate between two currencies over a given period equals the difference between the inflation rates of those two currencies
an expenditure changing policy
alters the level of the economy's total demand for goods and services
governments prefer to avoid excessive current account surpluses because
an addition to the home capital stock may reduce domestic unemployment and therefore lead to higher national income
52. what will be the effects of an increase in the money supply on the interest rate?
an increase in the money supply will cause interest rate to decrease. this should increase investment and possibly consumption of durable goods. the reduction of the interest rate will cause a depreciation of the dollar
65. explain the effects of a permanent increase in the US money supply in the short run and in the long run
an increase in the nominal money supply raises the real money supply, lowering the interest rate in the short run. the money supply increase is considered to continue in the future, thus, it will affect the exchange rate expectations. This will make the expected return on the euro more desirable, so the dollar depreciates. In the case of a permanent increase in the US money supply, the dollar depreciates more than under a temporary increase in the money supply.
the dollar rate of return on euro deposits is
approximately the euro interest rate plus the rate of depreciation of the dollar against the euro
how did the international monetary system create at bretton woods in 1944 allow its members to reconcile their external commitments with their internal goals of full employment and price stability
as the world economy evolved in the years after WWII, the meaning of "external balance" changed and conflicts between internal and external goals increasingly threatened the fixed exchange rate system. The US, the issuer of the principal reserve currency, was a major concern, leading to proposals to reform the system
by external balance, most economists mean
avoiding excessive imbalances in international payments.
countries where investment is relatively unproductive should
be net exporters of currently available output
until the united states civil war, the us had a
bimetallic monetary standard consisting of silver and gold
under fixed exchange rates, domestic asset transactions by the central bank
can be used to alter the level of foreign reserves but not to affect the state of employment and output
in the short run the interest rate
can rise when the domestic money supply falls
a permanent increase in a country's money supply
causes a proportional increase in its price level
under the gold standard era of 1870-1914
central banks tried to avoid sharp fluctuations in the balance of payments
which major actor is at the center of the forex market
commercial banks
given Pus and Yus, when the money supply rises, the dollar interest rate ____ and the dollar ______ agains the euro
declines, depreciates
inflation or deflation can occur
even under conditions of full employment
under the monetary approach to exchange rate theory, money supply growth at a constant rate
eventually results in ongoing price level inflation at the same rate, but changes in this long run inflation rate do not affect the full employment output level or the long run relative prices of goods and services
what is one component of the trilemma that is faced by policy makers in choosing monetary arrangements
exchange rate stability, freedom of international capital movements, monetary policy oriented towards domestic goals
the xx schedule shows how much
fiscal expansion is needed to hold the current account surplus at X as the currency is devalued by a given amount
by internal balance, most economists mean
full employment and price stability
the case of new zealand, described in the text, draws what technical conclusion regarding the country's international debt position
fundamentally, the question is whether or not a country can sustain a current account deficit indefinitely. the conclusion depends upon the country's future prospects. if net exporters are expected to rise at a rate sufficient to counteract the effects of debt over the relevant time period, then deficits could go on for an extended period
futures contracts differ from forward contracts because
future contracts allow you to sell your contract on an organized futures exchange
under the price-specie-flow mechanism, what happens when, say, great britain's current account surplus is greater than its non reserve financial account balance
gold reserves will flow into great britain
how did the international monetary system influence macroeconomic policy making and performance during the interwar period (1918-1939)
governments effectively suspended the gold standard during WWI and financed part of their massive military expenditures by printing money. Further, labor forces and productivity capacity had been reduced sharply through war losses. As a result, price levels were higher everywhere at the conclusion of the war in 1918. of special note is the german hyperinflation that occurred when prices in germany increased by a factor of 481.5 billion. the us returned to gold in 1919. in 1922, a group of countries including Britain, France, Italy and Japan agreed on a program of partial gold exchange standard in which smaller countries could hold as reserves the currencies of several large countries whose own international reserves would consist entirely of gold in 1925, britain returned to the gold standard by peggin the pound to gold at the prewar price. thus, the bank of england was therefore forced to follow contractionary monetary policies that contributed to severe unemployment and the decline of london as the leading financial center the world economy disintegrated into increasingly autarkic national units in the early 30s.
a change in the level of the supply of money
has no effect on the long run values of the interest rate and real output
The US price level will place a relatively
heavy weight on commodities produced and consumed in America, and the European price level will place a relatively heavy weight on commodities produced and consumed in Europe
under the monetary approach to the exchange rate, an interest rate increase is associated with
higher expected inflation and a currency that will be weaker on all future dates
explain how a country with a current account deficit is a ripe candidate for currency devaluation
if for example, great britain had a current account deficit, the holders of pounds would become nervous and shift their wealth into other currencies In order to hold the pound's exchange rate against the dollar pegged, the bank of england would have to buy pounds and supply the foreign assets that market participants wished to hold. this resulting loss in foreign reserves, if large enough, would most likely force a devaluation by leaving the bank of england without enough reserves to prop up the exchange rate
a revaluation restores internal and external balance
immediately without causing domestic inflation
a devaluation of the home currency
increases output and makes domestic goods and services cheaper relative to those sold abroad
if central banks were no longer obliged to intervene in currency markets to fix exchange rates, governments would be able to use monetary policy to reach
internal and external balance
countries with weak investment opportunities should
invest little at home and channel their savings into more productive investment activity abroad
advocates of floating rate suggested its favorable for economies for all of the following reasons except
it automatically matches the domestic inflation with ongoing foreign inflation
describe the effect of the smoot-hawley tariff imposed by the us in 1930
it had a damaging effect on employment abroad. the foreign response involved retaliatory trade restrictions and preferential trading arrangements among a group of countries. this is an example of beggar-thy-neighbor policy, meaning a policy that benefits the home country only because it worsens economic conditions abroad
a reduction in a country's money supply causes
its currency to appreciate in the foreign market
an increase in a country's money supply causes
its currency to depreciate in the foreign exchange market
an increase in the money supply will ____ the interest rate while a fall in the money supply will ____ the interest rate
lower, raise
a sudden increase in the US price level
makes those with dollar debts better off makes creditors in dollars worse off
a sudden decrease in the us price level
makes those with dollar debts worse off makes creditors in dollars better off
a current account surplus
may pose no problem if domestic savings are being invested more profitably abroad than they would be at home
a current account deficit
may pose no problem if the borrowed funds are channeled into productive domestic investments projects that pay for themselves with the revenue they generate in the future
under fixed exchange rates,
monetary policy is not an effective policy
changes in the money supply growth rate
need not to be neutral in the long run
what is an example of radio shack hedging its foreign currency risk
needing to pay 9000 yen per radio to its suppliers in a month, radioshack makes a forward exchange deal to buy yen
inflation can occur under condition of full employment
only if the central bank continues to inject money into the economy and the agents expectations of inflation are supported by the bank's activities
what is the nature of the trilemma that is encountered when choosing monetary arrangements
only two of the three aspects of internal and external balance can be accommodated simultaneously
what is are examples of financial derivatives?
options, forwards, swaps, futures
zone 2 (right)
overemployment, excessive current account deficit
zone 1 (top)
overemployment, excessive current account surplus
a permanent increase in a country's money supply causes a
proportional long run depreciation of its currency against foreign currency
an increase in real output _____ the interest rate, while a fall in real output _____ the interest rate
raises, lowers
absolute PPP implies
relative PPP
countries with large current account surpluses might be viewed by the market as candidates for
revaluation
the rules of the game under the gold standard can be best described as
selling domestic assets in a deficit and buying assets in a surplus
countries where investment is relatively productive
should have current account surpluses should be net importers of current output
countries with strong investment opportunities
should invest more at home and less abroad
the aggregate real money demand schedule l(R,Y)
slopes downward because a fall in the interest rate raises the desired real money holdings of each household and firm in the economy
a person holding dollar deposits during the devaluation of the dollar would
suffer a monetary loss and see the foreign currency value of dollar assets decrease by the amount of the exchange rate change
which is not a result of a temporary fall in foreign demand on one country's exports under floating exchange rate
the AA curve shifts downwards due to reduction of the money supply
if people expect relative PPP to hold
the difference between the interest rates offered by dollar and euro deposits will equal the difference between the inflation rates expected, in the US and Europe, respectively, over the relevant horizon
vehicle currency?
the dollar is sometimes called a vehicle currency because of its pivotal role in many forex deals
the dollar of the united states became the postwar world's key currency because of all except
the ease of transporting US dollars compared with other currencies
the collapse of the bretton woods system marked
the end of fixed exchange rates and a move to floating exchange rates
an economy's long run equilibrium is
the equilibrium that would occur if prices were perfectly flexible and always adjusted immediately to preserve full employment
under the monetary approach to the exchange rate,
the interest rate is not independent of the money supply growth rate in the long run while the long run interest rate does not depend on the absolute level of the money supply, continuing growth in the money supply will eventually affect the interest rate
aggregate money demand depends on
the interest rate, price level, and real national income
arbitrage?
the process of buying a currency cheap and selling it dear
advocates of flexible exchange rates claim that under flexible exchange rates
the united states would no longer be able to set world monetary conditions all by itself the US would have the same opportunity as other countries to influence its exchange rate against foreign currencies
the confidence problem of the bretton woods systems articulated by robert triffin refers to
the unwillingness of central banks to accumulate currency for fear of not being able to convert it to gold in case a run on the bank occurs
36. discuss the effects of a rise in the dollar interest rate on the exchange rate
there are two effects to consider. A rise in the interest rate offered by dollar deposits combined with a constant expected exchange rate will cause the dollar to appreciate. However the expected exchange rate will likely change. If the expected exchange rate increases, the dollar will depreciate.
for main industrial countries such as japan and the us,
there is much more month to month variability of the exchange rate, suggesting that price levels are relatively sticky in the short run
which is not a major actor of the forex market?
tourists
zone 3 (bottom)
underemployment, excessive current account deficit
zone 4 (left)
underemployment, excessive current account surplus
the gold standard period was
up until the first world war
97. discuss the different effects on the domestic interest rates when prices are assumed flexible and when they are assumed to be sticky
when prices are flexible, a decrease in the domestic money supply has no effect on the interest rate, because of the immediate decrease in the price level. however, when prices are assumed to be sticky, a decrease in the domestic money supply will cause the interest rate to rise, because the sticky domestic price level leads to an excess demand for real money balances at the initial interest rate.
under a flexible price monetary approach to the exchange rate
when the domestic money supply falls, the price level would fall right away, causing a reduction in the interest rate
an attempt by a central bank to alter the money supply by buying or selling domestic assets
will cause an offsetting change in foreign reserves and leave the domestic money supply unchanged
under the monetary approach to the exchange rate, a rise in the money supply
will cause immediate currency depreciation
a country seeking to maintain internal balance would be concerned
with large fluctuations in output or prices
92. does the existence of non tradable goods allow for deviations from PPP
yes, because the price of a nontradable is determined by its domestic supply and demand curves, and in turn fluctuations in demand and supply of these goods will affect the price level
