chapter 17

If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the U.S. dollar depreciates from ________ per dollar to ________ per dollar. 50¥; 100¥ 100¥; 50¥ 10¥; 5¥ 5¥; 10¥

100¥; 50¥

________ in the foreign interest rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant. A decrease; appreciate An increase; appreciate A decrease; depreciate An increase; depreciate

A decrease; appreciate

_______ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to appreciate, everything else held constant. A decrease; left An increase; right A decrease; right An increase; left

An increase; right

Explain and show graphically the effect of an increase in the expected inflation rate on the equilibrium exchange rate, everything else held constant.

Increased inflation (shift left) result in a rise in the domestic real interest, leading to a fall in the exchange rate (shift down). When there is an increase in the expected inflation rate, then the future value of domestic exchange rate will decrease, which in turn will decrease the expected return on assets. The domestic nominal interest rate increases the return on assets. The expected return on assets decreases causing a decrease in the demand for assets and causes the exchange rate to depreciate.

________ in the domestic interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant. A decrease; depreciate A decrease; appreciate An increase; depreciate An increase; appreciate

A decrease; depreciate

________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to depreciate, everything else held constant. A decrease; left An increase; left A decrease; right An increase; right

A decrease; left

________ in the expected future domestic exchange rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant. An increase; appreciate An increase; depreciate A decrease; appreciate A decrease; depreciate

An increase; appreciate

Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power parity explain all exchange rate movements in the short run? What factors determine long-run exchange rates?

The law of one price states that the price of traded goods should be the same in all countries, without trade barriers and low transport costs. The theory of purchasing power parity is one of the most prominent theories on how exchange rates are deteremined. It states that the exchange rate between any two countries currencies is such that a basket of goods and services, wherever it is produced, costs the same in both countries. It accounts for the exchange rate between, in example, the dollar and the japanese yen, being equal to 1.0, so that the purchasing power of the dollar is the same as that of other currencies. However, PPP does not take into account that many goods and services are nontradable (housing, land, and services like resturant meals), similar goods are not identical in both countries (toyota versus chevrolets are not the same cars so prices will be different), and there are trade barriers (tariffs, quotas). Whereas, long run exchange rates are determined by domestic price levels relative to foreign price levels, trade barriers, important and export demand, and productivity.

According to the Purchasing Power Parity, if one country's price level rises relative to another's by a certain percentage, then the other country's currency maintains its value. depreciates by the same percentage. lose its value. appreciates by the same percentage.

appreciates by the same percentage.

Although foreign exchange market trades are said to involve the buying and selling of currencies, most trades involve the buying and selling of gold. bank deposits denominated in different currencies. ECUs. SDRs.

bank deposits denominated in different currencies.

Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in the U.S. than was expected. Everything else held constant, the release of the CPI report would immediately cause the demand for U.S. assets to ________ and the U.S. dollar would ________. decrease; appreciate decrease; depreciate increase; depreciate increase; appreciate

decrease; depreciate