CH16

In practice A) changes in national price levels often tell us relatively little about exchange rate movements. B) changes in national price levels raise the exchange rate. C) changes in national price levels lower the exchange rate. D) changes in national price levels often tell us about exchange rate movements. E) changes in national price levels match identical changes in the exchange rate.

A

In the short run A) the interest rate can rise when the domestic money supply falls. B) the interest rate can decrease when the domestic money supply falls. C) the interest rate stays constant when the domestic money supply falls. D) the interest rate rises in the same proportion as the domestic money supply falls. E) the interest rate never rises when the domestic money supply falls.

A

Which of the following statements is MOST accurate? A) A relative expansion of U.S. output causes a long-run depreciation of the dollar against the euro, while a relative expansion of European output causes a long-run real appreciation of the dollar against the euro. B) A relative decline of U.S. output causes a long-run depreciation of the dollar against the euro, while a relative expansion of European output causes a long-run real appreciation of the dollar against the euro. C) A relative expansion of U.S. output causes a long-run appreciation of the dollar against the euro, while a relative expansion of European output causes a long-run real depreciation of the dollar against the euro. D) A relative expansion of U.S. output causes a long-run depreciation of the dollar against the euro, while a relative decline of European output causes a long-run real appreciation of the dollar against the euro. E) A relative decline of U.S. output causes a long-run depreciation of the dollar against the euro, while a relative decline of European output causes a long-run real appreciation of the dollar against the euro.

A

Which of the following statements is MOST accurate? A) In the money market, an increase in U.S. money supply level leads to a proportional increase in the long-run nominal dollar/euro exchange rate. B) In the money market, an increase in European money supply level leads to a proportional increase in the long-run nominal dollar/euro exchange rate. C) In the money market, an increase in U.S. money supply growth rate leads to a decrease in the long-run nominal dollar/euro exchange rate. D) In the money market, an increase in European money supply growth leads to an increase in the long-run nominal dollar/euro exchange rate. E) In the money market, an increase in U.S. money supply level leads to a proportional decrease in the long-run nominal dollar/euro exchange rate.

A

Which of the following statements is the MOST accurate? In general A) the monetary approach to the exchange rate is a long run theory. B) the monetary approach to the exchange rate is a short run theory. C) the monetary approach to the exchange rate is both a short and long run theory. D) the monetary approach to the exchange rate neither long run nor short run theory. E) the monetary approach to the exchange rate is considered less practical than the law of one price.

A

Discuss the differences between Absolute PPP 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.

What is the Fisher Effect? Provide an example

All else equal, a rise in a country's expected inflation rate will eventually cause an equal rise in the interest rate that deposits of its currency offer. Similarly, a fall in the expected inflation rate will eventually cause a fall in the interest rate. Ex: If the expected U.S. inflation were to rise permanently from Π to Π + ΔΠ, current dollar interest rates R$ would eventually catch up to the higher inflation, rising by a value ΔR$ = ΔΠ in accordance with the Monetary Approach that in the long run purely monetary developments should have no effect on an economy's relative prices since the real rate of return on dollar assets would remain unchanged.

Floating exchange rates A) systematically lead to much larger but less frequent short-run deviations from the absolute PPP. B) systematically lead to much larger and more frequent short-run deviations from the relative PPP. C) systematically lead to much smaller and less frequent short-run deviations from the relative PPP. D) systematically lead to much smaller but more frequent short-run deviations from the relative PPP. E) systematically lead to much smaller and less frequent short-run deviations from the absolute PPP.

B

Which of the following statements is MOST accurate? A) In the output market, an increase in demand for U.S. output leads to an increase in the long-run nominal dollar/euro exchange rate. B) In the output market, an increase in the demand for European output leads to an increase in the long-run nominal dollar/euro exchange rate. C) In the output market, a decrease in demand for U.S. output leads to a decrease in the long-run nominal dollar/euro exchange rate. D) In the output market, an increase in the demand for European output leads to a decrease in the long-run nominal dollar/euro exchange rate. E) In the output market, an increase in the demand for European output leads to an increase in the long-run nominal euro/dollar exchange rate.

B

Which of the following statements is the MOST accurate? A) Relative PPP is not a reasonable approximation to the data. B) Relative PPP is sometimes a reasonable approximation to the data but often performs poorly. C) Relative PPP is sometimes a reasonable approximation to the data. D) PPP is sometimes a reasonable approximation to the data. E) PPP is sometimes a reasonable approximation to the data but usually performs poorly.

B

Which of the following statements is the MOST accurate? A) The prices of identical commodity baskets, when converted to a single currency, are the same across countries. B) The prices of identical commodity baskets, when converted to a single currency, differ substantially across countries. C) The prices of identical commodity baskets, when converted to a single currency, do not differ substantially across countries. D) The prices of identical commodity baskets, when converted to a single currency, are often the same across countries. E) The prices of identical commodity baskets, when converted to a single currency, are the same across countries more than 50% of the time.

B

In the long run A) exchange rates obey relative PPP when all disturbances occur in the output markets. B) exchange rates obey absolute PPP when all disturbances occur in the output markets. C) exchange rates are unlikely to obey relative PPP when all disturbances occur in the output markets. D) exchange rates are unlikely to obey relative PPP when all disturbances are monetary in nature. E) exchange rates obey absolute PPP when all disturbances are monetary in nature.

C

Which of the following statements is the MOST accurate? A) If PPP holds true, then the law of one price holds true for every commodity as long as the reference baskets used to reckon different countries' price levels are the same. B) If the law of one price holds true for every commodity, PPP must hold automatically. C) If the law of one price holds true for every commodity, PPP must automatically hold as long as the reference baskets used to reckon different countries' price levels are the same. D) If the law of one price does not hold true for every commodity, PPP cannot be true as long as the reference baskets used to reckon different countries' price levels are the same. E) If PPP holds true, then the law of one price must hold true automatically.

C

Which of the following statements is the MOST accurate? A) Relative PPP may be valid even when absolute PPP is not, provided the factors causing deviations from absolute PPP are more or less stable over different commodities space. B) Absolute PPP may be valid even when relative PPP is not, provided the factors causing deviations from relative PPP are more or less stable over time. C) Relative PPP may be valid even when absolute PPP is not, provided the factors causing deviations from absolute PPP are more or less stable over time. D) Relative PPP is not valid when absolute PPP is not. E) Relative PPP is only valid when absolute PPP is valid, providing the factors causing deviations from relative PPP are more or less stable over time.

C

Which of the following statements is the MOST accurate? In general, under the monetary approach to the exchange rate A) while the short-run interest rate does not depend on the absolute level of the money supply, continuing growth in the money supply eventually will affect the interest rate. B) while the long-run interest rate does depend on the absolute level of the money supply, continuing growth in the money supply do not affect the interest rate. C) while the long-run interest rate does not depend on the absolute level of the money supply, continuing growth in the money supply eventually will affect the interest rate. D) the long-run interest rate does not depend on the absolute level of the money supply, and thus continuing growth in the money supply will not affect the interest rate. E) while the short-run interest rate does not depend on the absolute level of the money supply, continuing decline in the money supply eventually will not affect the interest rate.

C

Which one of the following statements is the MOST accurate? A) Relative price changes could not lead to PPP violations even if trade were free and costless. B) Relative price changes could lead to PPP violations only if trade were free and costless. C) Relative price changes could lead to PPP violations even if trade were free and costless. D) Price changes could lead to PPP violations even if trade were free and costless. E) Price changes could not lead to PPP violations even if trade were free and costless.

C

Which one of the following statements is the MOST accurate? A) The purchasing power of any given country's currency will increase in countries where the prices of non-tradable goods rise. B) The purchasing power of any given country's currency will fall in countries where the prices of non-tradable goods fall. C) The purchasing power of any given country's currency will fall in countries where the prices of non-tradable goods rise. D) The purchasing power of any given country's currency will remain constant in countries where the prices of non-tradable goods rise. E) The purchasing power of any given country's currency will fall in countries where the prices of non-tradable goods remain constant.

C

Which of the following statements is the MOST accurate? A) Absolute PPP does not imply relative PPP. B) Relative PPP implies absolute PPP. C) There is no causality relation between the two. D) Absolute PPP implies relative PPP. E) Absolute PPP is inversely related to relative PPP.

D

Which of the following statements is the MOST accurate? A) In the long run, national price levels play a minor role in determining both interest rates and the relative prices at which countries' products are traded. B) In the long run, national price levels play a key role only in determining interest rates. C) In the long run, national price levels play a key role only in determining the relative prices at which countries' products are traded. D) In the long run, national price levels play a key role in determining both interest rates and the relative prices at which countries' products are traded. E) In the long run, national price levels play no role in determining interest rates and the relative prices at which countries' products are traded.

D

Which of the following statements is the MOST accurate? A) The law of one price does fare well in all recent studies. B) The law of one price does fare well in many recent studies. C) The law of one price sometimes fares well in recent studies. D) The law of one price does not fare well in recent studies. E) The law of one price has not been studied recently.

D

Which of the following statements is the MOST accurate? In general, under the monetary approach to the exchange rate A) the interest rate is not independent of the money supply growth rate in the short run. B) the interest rate is independent of the money supply growth rate in the long run. C) the interest rate is not independent of the money supply growth rate in the long run, but independent in the short run. D) the interest rate is not independent of the money supply growth rate in the long run. E) the interest rate is a factor of the money supply growth rate only in the short term.

D

The PPP theory fails in reality for all of the following reasons EXCEPT A) transport costs. B) monopolistic or oligopolistic practices in goods markets. C) the inflation data reported in different countries are based on different commodity baskets. D) restrictions on trade. E) inflation rates are unrelated to money supply growth.

E

When the domestic money prices of goods are held constant A) a nominal dollar appreciation makes U.S. goods cheaper compared with foreign goods. B) a nominal dollar depreciation makes U.S. goods less appealing in foreign markets. C) a nominal dollar appreciation does not affect the prices of U.S. goods. D) a nominal dollar depreciation makes U.S. goods more expensive compared with foreign goods. E) a nominal dollar depreciation makes U.S. goods cheaper compared with foreign goods and a nominal dollar appreciation makes U.S. goods more expensive compared with foreign goods.

E

Which of the following statements is the MOST accurate? A) The law of one price applies only to the general price level. B) The law of one price applies to the general price level while PPP applies to individual commodities. C) The law of one price applies to individual commodities while PPP applies to both the general price level and to individual commodities. D) PPP applies only to individual commodities. E) The law of one price applies to individual commodities while PPP applies to the general price level.

E

Which one of the following statements is the MOST accurate? A) Departures from PPP are similar in both the short run and long run. B) Departures from PPP are even greater in the long run than in the long run. C) Departures from PPP are always greater in the short run than in the long run. D) It is hard to tell whether departures from PPP are greater in the short run than in the long run. E) Departures from PPP may often be greater in the short run than in the long run.

E

Under Purchasing Power Parity

E$/E = PUS/PE.

What can explain the failure of relative PPP to hold in reality?

Government measures of the price level differ from country to country. One reason for these differences is that people living in different countries spend their income in different ways. Because of this inherent difference among countries, certain baskets will be affected more by price changes given their consumptions basket. For example, consumers in country, X, eats more fish relative to another country. More than likely, the government, upon determining a commodity basket to reflect preference, will have an overwhelming representation of fish in their basket. Any price level change in the fish market will be felt particularly by country X, and their overall price level will reflect this. Thus, changes in the relative prices of basket components can cause relative PPP to become distorted.

In order for the condition E$/HK$ = PUS/PHK to hold, what assumptions does the principle of purchasing power parity make?

HK and the US are perfectly competitive and there are no transportation costs or restrictions on trade.

Discuss the effects of ongoing inflation based on the PPP theory.

Other things equal, money supply growth at a constant rate eventually results in ongoing price level inflation at the same rate as the money supply growth, 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.

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 (i.e. an increase in the domestic price level) will be associated with a proportional currency depreciation in the foreign exchange market and vice versa. = PUS/PE where P is the price of a reference commodity basket. Rearrange: PUS = × (PE) Thus, PPP asserts that all countries' price levels are equal when measured in terms of the same currency.

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 price rigidities. It assumes that prices can adjust right away to maintain full employment as well as PPP.

Explain why Relative PPP is useful when comparing countries that base their price levels on different product baskets.

Relative PPP is useful when comparing countries that base their price levels on different product baskets. Relative PPP may be valid even when absolute PPP is not.

Suppose Russia's inflation rate is 200% over one year but the inflation rate in Switzerland is only 2%. According to relative PPP, what should happen over the year to the Swiss franc's exchange rate against the Russian ruble?

So there will be a 198% depreciation of the ruble against the franc or, conversely, a 198% appreciation of the franc against the ruble.

Discuss the relationship between PPP and the Law of One Price.

The law of one price applies to individual commodities while PPP applies to the general price level. Proponents of PPP argue that its validity in the long run doesn't require the law of one price to hold exactly. When goods and services temporarily become more expensive in one country than in others, the demands for its currency and its products falls, pushing the exchange rate and domestic prices back in line with PPP and vice versa.

When all variables start out at their long-run equilibrium levels, the most important determinant of long-run swings in nominal exchange rates is

a change in relative inflation rates.

Under sticky prices

a fall in the money supply raises the interest rate to preserve money market equilibrium

An increase in the world relative demand for U.S. output causes

a long-run real appreciation of the dollar against the euro.

Under PPP (and by the Fisher Effect), all else equal

a rise in a country's expected inflation rate will eventually cause an equal rise in the interest rate that deposits of its currency offer.

Under the monetary approach to the exchange rate

a rise in the money supply will cause immediate currency depreciation

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.

Under sticky prices (part 2)

an interest rate rise is associated with lower expected inflation and a long-run currency appreciation, so the currency appreciates immediately.

Interest rate differences between countries depend on

differences in expected inflation, and on expected changes in the real exchange rate.

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.

Which of the following statements is the MOST accurate? The law of one price states

in competitive markets free of transportation costs and official barriers to trade, identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency.

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 United States and Europe, respectively, over the relevant horizon.

The monetary approach makes the general prediction that

the exchange rate, which is the relative price of American and European money, is fully determined in the long run by the relative supplies of those monies and the relative demands for them.

The expected rate of change in the nominal dollar/euro exchange rate is best described as

the expected rate of change in the real dollar/euro exchange rate plus the U.S.-Europe expected inflation difference.

Under a flexible-price monetary approach to the exchange rate

when the domestic money supply falls, the price level would fall right away, keeping the interest rate constant.