Intl Econ Exam 2- Ch 13, 14, ,15, 16, 18, 19
Calculate the dollar rate of return on a 5,000 pound sterling deposit in a London bank in a year when the interest rate on pounds is 10 percent and the dollar/pound exchange rate moves from $1.48 per pound to $1.71 per pound. The rate of return will be
((1.71 - 1.48) / 1.71) + 0.1
Calculate the dollar rate of return on a 5,000 pound sterling deposit in a London bank in a year when the interest rate on pounds is 8 percent and the dollar/pound exchange rate moves from $1.42 per pound to $1.55 per pound. The rate of return will be ______
(1.55-1.42)/1.42= 0.09 9 % + 8 % = 17.2
Calculate the real dollar rate of return on a 10,000 pound sterling deposit in a London bank in a year when the interest rate on pounds is 5 percent, the dollar/pound exchange rate moves from $1.77 per pound to $1.59 per pound, and the dollar prices increase by 10 percent. The real rate of return will be _____
(1.59 - 1.77) / 1.59 = -0.1132 -0.1132 + 0.05= -0.0632 subtract inflation percent
Suppose the expected future exchange rate, $1.65 per pound, and the US interest rate remain constant, while Britain's interest rate rises to 7 percent per year. What is the new equilibrium dollar/pound exchange rate?
(1.65) x (1+0.07)= 1.84
Calculate the dollar rate of return on a bottle of a rare Burgundy, Domaine de la Romanée-Conti 1978, whose price rises from $200 to $250 between 2013 and 2014. The rate of return will be
(250-200) / 200
Calculate the dollar rate of return on a painting whose price rises from $300,000 to $350,000 in a year. The rate of return will be _____ percent.
(350 - 300) / 350 = 16.7
Which of the following is not part of the definition for Gross National Product?
...produced within a country's borders...
Given the following data: Et = ¥110 = $1.00 Eet+1 = ¥118 = $1.00 R U.S. = 15% Assuming that Japan is the domestic currency, if the interest parity condition is expected to hold, interest rates in Japan (RJapan) should equal
15% + (118-110)/110
Suppose a bond issued by the European Central Bank and denominated in euros pays 7% per year. Today the exchange rate is 1.26 dollars per euro. It is expected that the exchange rate in one year will be 1.39 dollars per euro. What is the annual dollar return on this bond?
17 percent ((1.39 - 1.26)/1.39) + 0.07
Referring to the diagram on the right, in which years would you have chosen to visit the Tower of London rather than the Grand Canyon in Arizona?
1985 or 2001, the two lowest points
The graph on the right depicts real money supply. Using the three-point drawing tool, draw the aggregate money demand curve in the diagram to the right. Label this line 'L(R,Y)1 '. Now, suppose that real GNP rises. On the same graph, using another 3-point curve tool, draw the new aggregate real money demand. Label this line 'L(R,Y)2 '. As the result of a rise in real GNP, equilibrium in the money market will be at a _________ interest rate. Real money holdings will _________.
2 shifted right from 1 higher, remain unchanged
Suppose the return on a European bond is 8 percent per year. If we expect the US dollar to depreciate with respect to the euro by 15 percent in the next year, what is the expected dollar return on this European bond?
23 percent 8 + 15 = 23
In Munich a bratwurst costs 5 euros; a hot dog costs $8.00 at Boston's Fenway Park. At an exchange rate of $1.30/per euro, what is the price of a bratwurst in terms of hot dogs? a. The relative price of bratwurst is ______ hot dogs b. All else equal, how does this relative price change if the dollar depreciates to 1.40? Now the relative price is ____ hot dogs c. Compared with the initial situation, a hot dog has become ______ expensive relative to brat.
5 x 1.3 = 6.5 6.5/8 = 0.8125 hot dogs b. 1.4 x 5 = 7/8= 0.88 c. less expensive
Assume that the Uncovered Interest Parity (UIP) holds. If the rate of return on a euro asset is 7 percent and the rate of return on a comparable dollar asset is 5 percent, the expected rate of dollar depreciation must be
7 - 5 = -2
In the real world where relative PPP fails to hold, suppose that U.S. inflation is expected to exceed European inflation (πeUS−πeE) by66 percent for the foreseeable future. Furthermore, suppose that output demand and supply trends are widely expected to cause the dollar to decline against the euro in real terms at a rate of 1 percent per year. In this case, the international interest rate spread (R$−R€) will actually be
7 percent
The chapter explained why exporters cheer when their home currency depreciates. At the same time, domestic consumers find that they pay higher prices, so they should be disappointed when the currency becomes weaker. Why do the exporters usually win out, so that governments often seem to welcome depreciations while trying to avoid appreciations? (Hint: Think about the analogy with protective tariffs.)
A & B only A. Exporters constitute a relatively small group that is very well organized and has a lot at stake. B. Individual consumers have little incentive to act politically.
Expected real interest rates in all countries will be identical only when
A and C but not B A. relative PPP is expected to hold. B. inflation rates are identical in all countries. C. real exchange rates are not expected to change.
What is the "arbitrage" opportunity in the foreign exchange market?
A difference between the exchange rates in different trading centers
A. A decrease in the money supply leads to _______ in the value of the US dollar and __________ in the value of foreign currency. B. This in turn, leads to ________ in net exports and aggregate demand. C. A decrease in the money supply leads to __________ in interest rates. D. This, in turn leads to __________ in investment spending by firms and aggregate demand.
A. an increase, a decrease B. a decrease C. an increase D. a decrease
A. Draw the aggregate money demand curve (nominal money balances) in the diagram to the right. Label this line 'L(R,Y)1". B. Now suppose real GNP decreases. On the same graph, using the 3-point curve tool, draw the aggregate demand for money at this new price. Label this line 'L(R,Y)2". C. As a result of this change, the aggregate demand for money will ________
A. down slope from high Y to High x B. moves inside original curve C. decrease
Petroleum is sold in a world market and tends to be priced in U.S. dollars. The Nippon Steel Chemical Group of Japan must import petroleum to use in manufacturing plastics and other products, a large portion of which are sold in Japan. How are its profits affected when the yen depreciates against the dollar?
All else equal, the company's profits fall
Which of the following is most plausible as an explanation for relative PPP holding better in the long run than in the short run?
All the above - A. prices tend to be less sticky in the long run, thus lessening any deviation from PPP. B. it takes time for international trading firms to acquire and/or expand their "presence" in higher price markets. C. in the short run exchange rate fluctuations may be seen as temporary by trading firms.
If the U.S. dollar depreciates in terms of the Euro:
American goods would be cheaper for europeans
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.
How may the liquidity of euro and yen deposits be changing over time as capital markets become increasingly integrated?
Both yen and euro deposits are likely to become more liquid
Which of the following is NOT a major currency trading center?
Chicago
Does any of the discussion in this chapter lead you to believe that dollar deposits may have liquidity characteristics different from those of other currency deposits?
Dollar deposits are more liquid than deposits in other countries
How would the differences affect the interest differential between, say, dollar and Mexican peso deposits?
Dollar deposits will tend to offer lower interest rate than peso deposits
In October 1979, the U.S. central bank (the Federal Reserve System) announced it would play a less active role in limiting fluctuations in dollar interest rates. What do you expect will be the effect of this new policy on the volatility of the dollar's exchange rates against foreign currencies?
Dollar's exchange rates against foreign currencies are likely to become more volatile
Letting E$/£ and q$/£ denote, respectively, the nominal and real exchange rates between the U.S. dollar and the U.K. pound, which of the following accurately describes how these rates change when a permanent decrease occurs in the U.S. real money demand function?
E$/£ increasesincreases and q$/£ is unaffected.
Suppose the dollar interest rate and the pound sterling interest rate are the same, 22 percent per year. What is the relation between the current equilibrium dollar/pound exchange rate and its expected future level?
Expected dollar/pound exchange rate is equal to the current one.
How does a fall in the value of the pound sterling as shown in the diagram (very up & down, far lower at the end) to the right affect British consumers? b. How does this fall in the value of the pound affect American exporters?
Foreign goods are now relatively more expensive. British consumers are hurt. b. makes them worse off
Which of the following is NOT an account in the balance of payments?
Future account
Suppose there is a permanent reduction in aggregate real money demand, that is, a negative shift in the aggregate real money demand function. Trace the short-run and long-run effects on the exchange rate, interest rate, and price level. In the long run, the exchange rate will...
In the short run, the interest rate will fall, the expected return on foreign currency will increase, which results in a depreciation of the domestic currency. In the long run, the price level will rise to equate money demand with money supply at the initial (long run) interest rate. appreciate some as the interest rate returns to its long-run value but will depreciate relative to its initial value.
After convertibility was restored in Europe, what complicated monetary policy making for some countries in the mid to late 1960s?
Intermittent speculation of devaluations of revaluations
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.
Which of the following functions corresponds to a liquidity preference function and correctly identifies the relationship between the left-hand side variables and the right-hand side variables? (Note that Md is the quantity of money demanded, P the price level, i interest rates, Y real income, and f is the function operator that relates inputs to an output.)
Md/P= f (i-, Y+ )
The figure on the right shows the United States' end-of-year international investment position (IIP) as a percent of its nominal GDP for the period 1976-2012. The United States has run current account deficits in almost every year since the mid-1980s. Do the data in the graph therefore surprise you? (hint: compare current account deficit, as a percent of nominal GDP, with the growth rate of nominal GDP- current account/nominal GDP = -% up and down, growth rate on decline)
No, increasingly large current account deficits coupled with slowing growth in nominal GDP imply the trend shown for (IIP/NGDP) at right.
Do data on the U.S. official settlements balance give an accurate picture of the extent to which foreign central banks buy and sell dollars in currency markets?
No, this account provides only a partial picture because it shows a net value of all transactions.
How does a fall in government spending ultimately affect the central bank's balance sheet under a fixed exchange rate? How is this sale of foreign assets in the foreign exchange market by a central bank reflected in the balance of payments accounts?
The central bank's foreign assets fall as do domestic liabilities (currency in circulation). Credit is official financial inflow, debit is private financial outflow
If a currency reform has no effects on the economy's real variables, why do governments typically institute currency reforms in connection with broader programs aimed at halting runaway inflation? (There are many instances in addition to the Turkish case mentioned in the text. Other examples include Israel's switch from the pound to the shekel, Argentina's switches from the peso to the austral and back to the peso, and Brazil's switches from the cruzeiro to the cruzado, from the cruzado to the cruzeiro, from the cruzeiro to the cruzeiro real, and from the cruzeiro real to the real, the current currency, which was introduced in 1994.)
There may be a psychological benefit in that currency reform can have a positive effect on inflation expectations. However, for the stabilization plan to succeed, it must be backed up by concrete policies to reduce monetary growth.
We noted in this chapter that foreign central banks, especially in Asia, accumulated large dollar foreign reserves after 2000. One persistent worry was that those central banks, fearing dollar depreciation, would shift their reserve holdings from dollars to euros. If dollar and euro assets are perfect substitutes, what is a likely effect of such actions? If dollar and euro assets are imperfect substitutes, what is a likely effect of such actions?
These actions will have no effect on exchange rate these actions will lead to dollar depreciation against the euro
Which of the following is NOT a valid argument in favor of a floating exchange rate regime?
This regime increases the efficiency of international trade
A New Yorker travels to New Jersey to buy a $100 telephone answering machine. Suppose that he pays with cash for the machine. How would this transaction show up in the balance of payments accounts of New York and New Jersey?
This transaction will show up as *debit* in the *current* account of New York and as *credit* in the *current account* of New Jersey. The offsetting transaction will show up as *credit* in the *financial* account of New York and as *debit* in the financial account of New Jersey.
Multinationals generally have production plants in a number of countries. Consequently, they can move production from expensive locations to cheaper ones in response to various economic developmentslong dash—a phenomenon called outsourcing when a domestically based firm moves part of its production abroad. If the dollar depreciates, what would you expect to happen to outsourcing by American companies?
We would expect outsourcing by american companies to diminish
Does our discussion of money's usefulness as a medium of exchange and unit of account suggest reasons why some currencies become vehicle currencies for foreign exchange transactions? (The concept of a vehicle currency was discussed in Chapter 14.)
Yes. The more currencies used in trade, the closer the trade becomes to barter, which raises transaction and calculation costs.
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
Under a floating exchange rate regime, in the short run an increase in taxes in Europe would necessarily lead to
a decline in both european and US output
Assuming that each of the three policy regime labels along the triangle's edges is consistent with the two goals that it lies between in the diagram, Policy regime 2 best represents
a floating exchange rate
Exchange rate: a. Using $100 to purchase the Israeli currency directly would obtain b. Instead of buying shekels directly, an arbitrager may first buy British pounds and then use these funds to purchase shekels. In this case, an outlay of $100 will obtain _____ shekels. c. These newly obtained shekels may then be used to purchase $_____, yielding the arbitrager a profit of $ ____. d. As traders/investors pursue this riskless profit opportunity, it will quickly disappear since their actions will cause the following exchange rate adjustments:
a. 100 / 3.2 (us price of shek) b. 100 / 88 (pound price of $) = 88 / 2.2 (pound price shekel) = 40 c. 40 x 3.2 (us price of shekel) = 128, 128-100= 28 profit d. The British pound price of a shekel appreciates, the British pound price of a dollar depreciates, and the U.S. dollar price of a shekel depreciates.
Given the following data: Et = ¥100 = $1.00 Et+1 = ¥90 = $1.00 {one year later} iJapan = 8% annually iU.S. = 12% annually a. If the $1000 is invested in the U.S., the future value is b. If the $1000 is invested in Japan (and repatriated back to dollars), the future value is
a. 1000(1.12)= 1120 b. (1000x100) x (1.08)/90= 1200
a. When the dollar is worth less in relation to currencies of other countries (for example relative to the Japanese Yen in the diagram to the right- goes down), are you more likely to buy American-made or foreign-made electronics? b. Are U.S. companies that manufacture semi-conductors happier when the dollar is strong or when it is weak? c. What about an American company that is in the business of importing electronic consumer goods into the United States?
a. American (domestic products) b. when the dollar is weaker c. when the dollar is stronger
Identify the following as debit or credit entries in the Balance of Payments: Export Expenditure: Foreign Assets held in US: Income payments: Official Reserve Assets: US Assets held abroad:
a. credit in current account b. debit in financial account (capital) c. debit in current d. debit in financial e. credit in financial
a. Show the effect of a decline in the dollar interest rate. Properly label this line. b. This shock will lead to a dollar __________
a. moved to the left b. depreciation
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
Large-scale wars typically bring a suspension of international trading and financial activities. Exchange rates lose much of their relevance under these conditions, but once the war is over governments wishing to fix exchange rates face the problem of deciding what the new rates should be. The PPP theory has often been applied to this problem of postwar exchange rate realignment. If you were the British Chancellor of the Exchequer and World War I had just ended, a good first approximization to identifying the appropriate post-war dollar/pound exchange rate might be obtained by If, during the war, the U.S. price level increased by 88% while the U.K. level rose by 1414%, a best-guess post-war dollar/pound exchange rate would be, compared to the pre-war rate ________ Using the PPP theory in this manner may be a bad idea if
adjusting the pre-war rate according to the price level changes experienced by the two countries during the war. 6% All the above (relative demands for the goods produced in the countries changed substantially, the two countries had significantly different wartime changes in productive capacity, productivity trends in the two countries were disparate during the war.)
A managed floating exchange rate refers to
an exchange rate that is not pegged, but does not float freely
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?
both public saving and private saving will rise investment will remain the same
Imperfect asset substitutability:
can arise if different assets have different levels of risk
Gross National Product represents the sum of the following expenditure categories:
consumption, investment, government purchases, and the current account balance.
Which countries suffered most in the Great Depression?
countries who stayed on Gold the longest
Under a gold standard of the kind analyzed by Hume, if there is a transfer of income from country B to country A, how would balance of payments equilibrium between the two countries be restored? Initially, the income transfer would Then,
create a current account surplus in A and a current account deficit in B gold flows from B to A, pushing up prices in A and depressing prices in B, until equilibrium is restored.
Suppose the dollar exchange rate of the euro and the yen are equally variable. The euro, however, tends to depreciate unexpectedly against the dollar when the return on the rest of your wealth is unexpectedly lowlow, while the yen tends to appreciate in the same circumstances. As a U.S. resident, which currency, the euro or the yen, would you consider riskier? For a U.S. resident, the _____ is more risky.
euro
In the short run of a model with sticky prices, a reduction in the money supply raisesraises the nominal interest rate and appreciates the currency. In this case the country's expected real interest rate will __________. In addition, the real exchange rate, after initially _________, will subsequently __________. The latter movement of the real exchange rate satisfies the real interest parity condition which indicates that a country's currency will be expected to undergo a real depreciation when its real interest rate __________ rates elsewhere.
increase decreasing, increase rises above
What accounts for most of the activity in the foreign exchange market?
interbank trading
If the interest rate on a deposit in Euros is 6% per year, and the Euro is expected to depreciate against the U.S. dollar by 1%, what does the interest parity condition imply about the interest rate on the deposit in U.S. dollars?
interest - depreciate 6 - 1 = 5%
Suppose that under the postwar "dollar standard" system foreign central banks had held dollar reserves in the form of green dollar bills hidden in their vaults rather than U.S. Treasury bills. Which of the following is true about the international monetary adjustment mechanism in this situation?
it would have been symmetric
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
Show the effect of a decline in the dollar interest rate. Properly label this line. This shock will lead to a dollar ________
moves to left, depreciation
The figure on the right shows aggregate real money demand L(R,Y) and the initial money supply. Now, suppose the price level rises (this is a one-time change). Using the line drawing tool, draw the new real money supply on the same graph and label it 'MS2 '. The figure on the right shows aggregate real money demand L(R,Y) and the initial money supply. Now, suppose the price level risesrises (this is a one-time change). Using the line drawing tool, draw the new real money supply on the same graph and label it 'MS2 '. Carefully follow the instructions above and only draw the required object. As the result of this change in the price level, equilibrium ______ will _________
moves toward Y axis interest rate, rise
GNP (Gross National Product) equals GDP plus
net receipts of factor income from the rest of the world.
Which of the following correctly represents the formula for relative PPP?
piUS = pi E,t + (E$/e,t - E$/e,t-1)/ E$/et-1
If there is a decline in output, to keep the exchange rate fixed, the central bank has to
sell foreign assets
We observed that "fixed" exchange-rate systems can result not in absolutely fixed exchange rates but in narrow bands within which the exchange rate can move. For example, the gold points produce such bands under a gold standard. To what extent would such bands for the exchange rate allow the domestic interest rate to move independently of a foreign rate? If a band is plus or minus 2 percent (the difference between the top and the bottom is 4 percent) what is the maximum possible change in the interest rate on 10-year loans, assuming no change in the foreign interest rate?
short maturities interest rates will be able to change by more than those on long-maturities 0.4 % (4/10)
The opportunity cost of money holdings is
the alternative interest income forgone from not holding some other asset
A country is said to be in balance of payments equilibrium when
the current plus capital account balance is financed entirely by private international lending without official reserve movements
In theory, the equality: current account + capital account + financial account = 0 must hold. In reality a statistical discrepancy is often included to achieve this balance. Which account is the likely culprit of this discrepancy?
the financial account
Worldwide importing inflation from the U.S. at the end of Bretton Woods was caused by
the need to increase monetary growth to match the US
The asymmetry of a reserve currency system refers to the fact that
the reserve country has a fixed exchange rate but can still use domestically-oriented monetary policy
If a country changes its exchange rate, the value of its foreign reserves, measured in the domestic currency, also changes. This latter change may represent a domestic-currency gain or loss for the central bank. What happens when a country devalues its currency against the reserve currency? If this change in the exchange rate is expected, how will it affect the cost of holding foreign reserves? If this change in the exchange rate is unexpected, how will it affect the cost of holding foreign reserves?
the value of foreign reserves measured in local currency will increase there will be no change in the cost of foreign reserve there will be a capital gain on foreign reserves
One argument against float is the lack of discipline imposed on central banks. How do the pro-floaters respond to this argument?
under float, inflation is contained in the country that creates it
How might restrictions on private financial account transactions (capital controls) alter the problem of attaining internal and external balance with a fixed exchange rate? The difference between a fixed exchange rate regime with capital controls and fixed exchange rate regime without capital controls is that What costs might such restrictions involve?
with capital controls monetary policy can be used to achieve internal balance inefficiency due to interest rate differential, high costs of enforcing capital controls
Why did world central banks need to continue to accumulate dollars in the Bretton Woods system?
world gold was not rising fast enough to satisfy reserves demand
