Exchange Rate Final - HW Questions
what changes will shift the AA schedule in the short run?
- an increase in the domestic money supply - an increase in the foreign money supply - an increase in the expected future exchange rate (E^e $/€)
what changes will shift the DD schedule in the short run?
- an increase in the domestic price level - an increase in govt purchases - an increase in the foreign price level
Which of the following correctly represents the formula for absolute PPP? Remember that P stands for the price level and E stands for the level of the exchange rate.
PUS = E$/€ × PE
What are the determinants of the aggregate money demand?
Price level, national income, and interest rate.
What is the interest parity condition under a fixed exchange rate regime?
R=R*
For a given Euro interest rate, what is the correct causality chain in the short run?
The Fed determines real money balances, which in turn determine the interest rate, given money demand, which, given the interest parity condition, determines the Euro/dollar exchange rate.
What does exchange rate overshooting describe?
The exchange rate changes in the short run by more than in the long run.
an increase in the real exchange rate (real depreciation of domestic currency) will result in
an increase in net exports
A permanent increase in the money supply (beginning from full employment) will lead to
an increased price level (P)
domestic assets
are central bank holdings of claims to future payments by its own citizens and domestic institutions
XX is flatter than DD because
as GDP increases along DD, domestic demand increases less than supply, so some must be exported.
If a country begins from full employment, a permanent increase in government spending wil
cause E v$/€ to fall
GNP (Gross National Product) equals GDP plus
net receipts of factor income from the rest of the world.
A temporary fiscal expansion in an economy produces
no change in the long-run expected exchange rate, an appreciation of its currency, and a rise in its output and employment.
A temporary decrease in an economy's money supply produces
no change in the long-run expected exchange rate, an appreciation of its currency, and a fall in its output and employment.
As the result of a decline in the nominal money supply, the interest rate will ___ in the short-run.
rise
If there is a decline in output, to keep the exchange rate fixed, the central bank has to
sell foreign assets
an increase in disposable income worsens the current account because
consumers demand more of all goods, including imported goods while exports are not affected
If the economy's output is initially above full employment, which of the following policy combinations could restore full employment and keep the exchange rate at the same level?
contractionary monetary and fiscal policy
As a result of a rise in the interest rate, the quantity of aggregate real money demanded will
decrease
If central banks are not sterilizing and the home country has a balance of payments surplus, any associated
decrease in foreign central bank's claims on the home country implies a decreased foreign money
Suppose Home (H) imposes a tariff on imports from Foreign (F). All else equal, this action will cause the long-run real Home/Foreign exchange rate to ______ and the long-run nominal Home/Foreign exchange rate to ______
decrease; decrease
When the central bank buys foreign assets (and makes no other changes),
domestic money supply increases because central bank liabilities rise as well.
In the long-run, prices will fully adjust—they will decline proportionally to the change in the nominal money supply. Therefore, in the long-run the interest rate will be
equal to the initial interest rate.
True or False: No permanent shock moves both AA and DD at the same time; they are separate
false
If a government initially has a balanced budget but then cuts taxes, it is running a deficit that it must somehow finance. Suppose people think the government will finance its deficit by printing the extra money it now needs to cover its expenditures. In this case, the tax cut will...
have an ambiguous effect on the exchange rate
A temporary fiscal expansion (with full employment) will
increase GDP
If the expected real interest rate in the United States is 9 percent per year while that in Europe is 3 percent per year, it can be anticipated that over the next year the real dollar/euro exchange rate will
increase, resulting in a real depreciation of the dollar against the euro
In the current Post-Industrial economy, international trade in services (including banking and financial services)
is relatively small.
If the central bank's foreign assets fall, central bank
liabilities can rise or fall depending on the change in central bank domestic assets.
In the present, most of the exports from China are in
manufactured goods.
Under imperfect asset substitutability
sterilized intervention affects money supply.
The opportunity cost of money holdings is
the alternative interest income foregone from not holding some other asset.
According to the gravity model, a characteristic that tends to affect the probability of trade existing between any two countries is
the distance between them.
the volume effect is
the effect of a change in the real exchange rate on imports and exports
the value effect is
the effect of a change in the real exchange rate on the value of foreign imports in terms of domestic output
It is often asserted that exporters suffer when their home currencies appreciate in real terms against foreign currencies. This exporter "experience" stems from the fact that, ceteris paribus,
the price of home goods relative to foreign goods rises when the home currency appreciates.
the current account will increase if
the real exchange rate depreciates or disposable income goes down
what happens in a domestic economy when the government imposes a temporary tariff on all imports?
there will be a rise in output and the domestic currency will appreciate
True or False: A permanent increase in government spending (starting at full employment) moves AA and DD in the short-run
true
True or False: A permanent increase in the money supply depreciates the currency
true
True or False: A permanent increase in the money supply (starting at full employment) moves AA and DD in the long-run
true
In claiming that "size matters," the gravity model asserts that there is a strong empirical relationship between the size of a country's economy and the
volume of its imports and exports.
GNP accounts avoid double counting by including only the value of final goods and services sold on the market. Should the measure of imports and exports used in the GNP accounts therefore be defined to include only imports and exports of final goods and services received from and sold to other countries?
No, total values and imports and exports should be included in the calculation of the GNP.
Gross National Product represents the sum of the following expenditure categories:
consumption, investment, government purchases, and the current account balance.
Which of the following temporary policies increases the current account and increases GDP (starting from full employment)?
Monetary expansion
What is the short-run effect on the exchange rate of an increase in domestic real GNP, given expectations about future exchange rates?
Money demand increases, the domestic interest rate increases, and the domestic currency appreciates.
Suppose the return on a European bond is 9 percent per year. If we expect the US dollar to depreciate with respect to the euro by 18 percent in the next year, what is the expected dollar return on this European bond?
27 perfect
A sterilized foreign exchange intervention
always leaves the money supply unchanged.
Which of the Federal Reserve's measures of the monetary aggregates is composed of the most liquid assets?
M1
Which of the following is most plausible as an explanation for relative PPP holding better in the long run than in the short run?
- in the short run exchange rate fluctuations may be seen as temporary by trading firms. - prices tend to be less sticky in the long run, thus lessening any deviation from PPP. - it takes time for international trading firms to acquire and/or expand their "presence" in higher price markets.
A temporary decrease in government spending causes the current account to rise by a smaller amount than a permanent decrease in government spending does because the
- latter induces an increase in the expected future exchange rate - latter induces a depreciation of the currency's expected future value - former has no effect on expectations on future exchange rates
The government implements a permanent expansionary fiscal policy, which corresponds to an increase in US government spending or a fall in the US tax rates. What will happen to output and the exchange rate?
- output will not change - the exchange rate will fall
The government implements a temporary expansionary monetary policy, which corresponds to an increase in the US money supply. As a result, what will happen to output and the exchange rate in the short run?
- output will rise - the exchange rate will rise
what happens when a temporary tariff on all imports becomes permanent?
- the expected future exchange rate, E^e, will decrease - the DD curve will shift down the AA schedule - output will decrease - the domestic currency continues to appreciate
Devaluation is often used by countries to improve their current accounts. The current account, however, equals national saving less domestic investment. Given the assumptions we made about saving and investment, how will devaluation affect national saving and investment? What is the effect on saving? What is the effect on investment?
1. Both public saving and private saving will rise. 2. Investment will remain the same.
A decrease in the money supply leads to (1) in the value of the U.S. dollar and (2) in the value of foreign currency. This in turn, leads to (3) in net exports and aggregate demand. A decrease in the money supply leads to (4) interest rates. This, in turn, leads to (5) in investment spending by firms and aggregate demand.
1. a increase 2. a decrease 3. a decrease 4. an increase 5. a decrease
As the result of a fall in real GNP, equilibrium in the money market will be at a (1) interest rate. Real money holdings will (2)
1. lower 2. remain unchanged
What is the effect of an increase in taxes under fixed exchange rates and perfect asset substitutability in the short run?
A decline in output and no change in interest rates.
What is the "arbitrage" opportunity in the foreign exchange market?
A difference between the exchange rates in different trading centers.
What is M1?
A monetary aggregate that includes currency in circulation and checkable deposits.
Based on purchasing power parity (PPP), which of the following, all else being equal, could lead to a long-run real appreciation of the U.S. dollar?
A rise in the growth rate of the U.S. GDP.
Among M1 and M2, which is the largest measure?
M2
If the U.S. dollar depreciates in terms of the Euro:
American goods would be cheaper for Europeans.
Which of the following is a correct prediction based on the PPP model of the exchange rates?
An increase in the U.S. interest rates leads to depreciation of the dollar.
Which combination of policies would achieve a lower interest rate while maintaining the fixed exchange rate?
An increase in the money supply and a sale of foreign assets
Which of the following assets is the most liquid? A. A traveler's check. B. An automobile. C. A U.S. savings bond. D. 50 shares of Microsoft stock.
A traveler's check
Shall a government be concerned about a large current account deficit or surplus?
Both current account surplus and deficit might not be sustainable in a long run and are thus a concern.
Which of the following is NOT a function of money? A. Store of value. B. Capital used to produce goods and services. C. Medium of exchange. D. Unit of account.
Capital used to produce goods and services.
How does fiscal contraction affect the current account under a fixed exchange rate?
Current account improves as a result of a fiscal contraction.
Which of the following is NOT a valid explanation for the failure of the data to support PPP theory? A. Trade barriers. B. Transportation costs. C. Differences in price level measurements across countries. D. Differences in monetary policies across countries
D. Differences in monetary policies across countries
The difference between Gross National Product (GNP) and National Income is a trivial amount.
False. National income equals GNP less depreciation plus net unilateral transfers.
How do we distinguish in the model between the short run and the long run?
In the short run price level is fixed; in the long run, it is flexible.
What accounts for most of the activity in the foreign exchange market?
Interbank trading.
How might a zero interest rate complicate the task of monetary policy?
It cannot respond to an adverse shock to the economy by lowering interest rates. One option is to increase inflation by purchasing bonds to stimulate the economy. Increasing inflation with a constant zero interest rate lowers the real interest rate.
What does PPP imply?
The real exchange rate is equal to 1.
How would you expect a fall in a country's population to alter its aggregate money demand function? Would it matter if the fall in population were due to a fall in the number of households or to a fall in the average size of a household?
There would be a decrease in money demand because there would be fewer transactions. The decrease in money demand would be larger if the decrease in population was due to a fall in the number of households.
If the central bank purchases assets, it will result in
am increase in the money supply
A managed floating exchange rate refers to
an exchange rate that is not pegged, but does not float freely.
The monetary approach to the exchange rate predicts that the dollar will appreciate in the long run if, ceteris paribus,
US interest rate falls or European interest rate rises
In an open economy holding GNP and consumption spending constant and where private savings equals domestic investment, a government budget deficit must be matched by
a current account deficit.
Which of the following assets is the least liquid? A. A share of publicly traded stock. B. Currency. C. A house. D. A three-month Treasury bill.
a house
If the prices of identical commodity baskets, after conversion to a single currency, differ markedly across countries, it can be concluded that
absolute PPP is way off the mark