Inter Macro 3rd Exam - HW 12

Which of the following would cause the exchange rate for a currency to rise?

- An increase in the domestic interest rate - A decrease in the foreign interest rate - The expected future exchange rate for the currency rises

What is the policy trilemma?

A country cannot simultaneously have; 1.) Free capital mobility 2.) Fixed exchange rate 3.) Independent monetary policy

What is an advantage of exchange-rate pegging?

It can help keep inflation low and anchors inflation expectations

Nominal Exchange Rate

Nominal Exchange Rate = (Foreign Price)/(Domestic Price)

The real exchange rate is denominated in terms of

Purchasing power

Suppose a bottle of wine sells for $8 in California and for €4 in France. Assuming a nominal exchange rate of 0.75 euro per dollar, calculate the real exchange rate between U.S wine and French wine.

Real Exchange Rate = (0.75*8)/(4) = 1.50

Real Exchange Rate

Real Exchange Rate = (Nominal Exchange Rate * Domestic Price)/(Foreign Price)

Relative Price

Relative Price = Domestic Price/Foreign Price

Maintaining a fixed exchange rate requires that the country's central bank...

Sells international reserves

What problems can selling international reserves create?

The central bank will exhaust its international reserves and be unable to maintain the exchange rate

Suppose that the Federal Reserve cannot convince the public of its commitment to fight inflation in the U.S. in the near future. What would be the effect on the expected appreciation of the U.S. dollar?

The dollar would be expected to DEPRECIATE in the future

Assume a country has pegged the value of its currency to another country's currency and that the anchor currency's country increases its interest rate.

The export sector of the pegging country will LOSE from this change

A currency is said to be overvalued if;

The fixed exchange rate is greater than the equilibrium value.

If the pegging country is forced to devalue its currency and most debts are denominated in the foreign (anchor) currency,

The net worth of households in the country will DECREASE

What is a disadvantage of exchange-rate pegging?

The pegging country cannot pursue an independent monetary policy and risks speculative attacks

The appreciation or depreciation of real exchange rates is important because the affect

The relative prices of imports and exports

Assume that currently the nominal exchange rate is 1.5 yuan per dollar. What would be the purchasing power parity theory prediction about the future value of the nominal rate?

The yuan would be expected to depreciate

The nominal exchange rate and real exchange rate move _________

Together

The Fed may begin reducing the size of its $85 billion in monthly asset purchases sooner than expected. What effect should this have on interest rates and dollar exchange rates?

U.S. interest rates will increase and the dollar will appreciate

The Fed worried that markets overreacted, and several Fed officials including the Chairman strongly reiterated that reductions of asset purchases would begin only if economic conditions warranted, indicating that reductions in asset purchases may not happen sooner than expected. What effect should this have on interest rates and dollar exchange rates?

U.S. interest rates will likely recede from their post-press conference rise and the dollar will similarly decline

The nominal exchange rate is denominated in terms of

Units of foreign currency