EC 340 MSU Exam II HW VIII

If a basket of goods in Home costs PH = 10 and in Foreign PF = 25, then for the law of one price to hold, E, the price of the Home currency in terms of the Foreign currency, must equal

5/2

Which of the following would be consistent with the hypothesis that US productivity growth is causing trade deficits:

A Increases in stock prices over and above current earnings B Increased consumption as a ratio of GDP

We expect the Dollar to be worth 250 Yen in one year's time. What additional information do we need to know in order to calculate the current exchange rate?

A The one-year interest rate in Japan B The one-year interest rate in the US

Which might be a reason for why we might not see the law of one price in the data over the in the long-run?

A Transport costs B Information costs C Travel time of goods across the globe

What theoretical force enforces the Purchasing Power Parity condition?

Arbitrage agents

If the dollar is expected to appreciate, then the dollar return on a foreign asset will...

Be lower than the nominal (coupon) rate on the asset (the rate paid in foreign currency).

Consider the following statements i) Higher expected future income means people want to consume more today ii) Predicted high future productivity implies higher expected future income

Both are true

The world has two periods: today and tomorrow. The US opens up to trade with the rest of the world. The new interest rate in the global economy is lower than the interest rate in the US under autarky. Relative to its consumption pattern under autarky, the US will

C Invest more today Consume a higher share of total income today today and a lower share in the future (save less today)

US interest rates decreases, increasing expected future inflation [in the US]. This [ ] the expected exchange rate. In order to maintain interest rate parity between the USD and the Japanese Yen, the spot exchange rate must adjust [ ] over time and [ ] immediately.

Decreases; upward over time; jump down.

Which of the following determines the expected exchange rate?

Expected inflation in Home

True or False: The Big Mac index shows that the Purchasing Power Parity condition is upheld in the real world (in the data).

False

Evaluate the following statement using the model of trade deficits we learned in class: "Our country's trade deficit means that future generations will have to pay other countries back and will have less to consume than if we ran a balanced trade account". This statement is

False: while in the future we will have to run trade surpluses if we run a trade deficit in the current period, increased investment means our absolute future consumption may be higher.

If the domestic and foreign interest rates are 12% and 10% respectively, then according to the interest rate parity condition,

Foreign's currency is expected to appreciate by 2%

What is the relationship between exchange rates and inflation?

Higher domestic inflation is associated with a decrease in the exchange rate (price of domestic currency) in the long-run.

Which of the following is a statement of purchasing power parity?

In the long run, the purchasing power of one unit of currency must be the same when converted into any other currency.

Inflation in Japan increases. This[ ]. In order to maintain interest rate parity,[ ] must adjust [ ].

Increases the expected exchange rate; the spot exchange rate; upward.

If a basket of goods in Home costs PH and PF in Foreign, and E is the price of the Home currency in terms of the Foreign currency, which of the following is the Purchasing Power Parity equation?

PH * E = PF

Suppose price of big mac in US is $2 and that in France is 1 Euro and existing exchange rate between dollar and euro (E) is 0.38 (i.e. one dollar can be purchased for 0.38 Euros), then

The Euro is predicted to depreciate over the next four years

US manufacturers receive news that profits from current-period investments will be taxed at a higher rate. What effect will this have on the present US current account deficit? NOTE: A decrease in the current account deficit means the current account becomes less negative.

The current account deficit will likely decrease (become less negative)

US companies observe an increasing percent of the population attending college, likely increasing the future productivity of their workforce, and spurring present-day investment in order to adjust to the increasing marginal product of labor. What effect will this have on the US current account deficit in the present?

The current account deficit will likely increase

If US bonds pay 10% interest, and Korean bonds pay 7% interest, then according to the interest rate parity condition,

The dollar must depreciate by about 3% this year.

Inflation in the US is 6% while inflation in the UK is 3%. According to PPP, the expected long-run change in the exchange rate is:

The price of the USD in terms of GBP will decrease by 3 percent

What variable in the IRP equation adjusts to preserve the interest rate parity in response to a macroeconomic shock?

The spot (current) exchange rate

Interest rates in Japan increase, with no effect on inflation. In our model, what will adjust in order to maintain interest rate parity?

The spot (current) exchange rate of USD drops instantly (USD decreases in value)

US government bonds pay X% and UK government bonds pay Y%. The current exchange rate is Z (the price of 1 USD is Z GBP). What is the future exchange rate?

{(100+Y)/(100+X)}*Z