Exchange Rate Final - HW Questions

what changes will shift the AA schedule in the short run?

- an increase in the domestic money supply - an increase in the foreign money supply - an increase in the expected future exchange rate (E^e $/€)

what changes will shift the DD schedule in the short run?

- an increase in the domestic price level - an increase in govt purchases - an increase in the foreign price level

Which of the following correctly represents the formula for absolute​ PPP? Remember that P stands for the price level and E stands for the level of the exchange rate.

PUS ​= E$/€ × PE

What are the determinants of the aggregate money​ demand?

Price​ level, national​ income, and interest rate.

What is the interest parity condition under a fixed exchange rate​ regime?

R=R*

For a given Euro interest​ rate, what is the correct causality chain in the short​ run?

The Fed determines real money​ balances, which in turn determine the interest​ rate, given money​ demand, which, given the interest parity​ condition, determines the​ Euro/dollar exchange rate.

What does exchange rate overshooting​ describe?

The exchange rate changes in the short run by more than in the long run.

an increase in the real exchange rate (real depreciation of domestic currency) will result in

an increase in net exports

A permanent increase in the money supply​ (beginning from full employment) will lead to

an increased price level (P)

domestic assets

are central bank holdings of claims to future payments by its own citizens and domestic institutions

XX is flatter than DD because

as GDP increases along​ DD, domestic demand increases less than​ supply, so some must be exported.

If a country begins from full​ employment, a permanent increase in government spending wil

cause E v$/€ to fall

GNP​ (Gross National​ Product) equals GDP plus

net receipts of factor income from the rest of the world.

A temporary fiscal expansion in an economy produces

no change in the​ long-run expected exchange rate, an appreciation of its​ currency, and a rise in its output and employment.

A temporary decrease in an​ economy's money supply produces

no change in the​ long-run expected exchange rate, an appreciation of its​ currency, and a fall in its output and employment.

As the result of a decline in the nominal money​ supply, the interest rate will ___ in the​ short-run.

rise

If there is a decline in​ output, to keep the exchange rate​ fixed, the central bank has to

sell foreign assets

an increase in disposable income worsens the current account because

consumers demand more of all goods, including imported goods while exports are not affected

If the​ economy's output is initially above full​ employment, which of the following policy combinations could restore full employment and keep the exchange rate at the same​ level?

contractionary monetary and fiscal policy

As a result of a rise in the interest​ rate, the quantity of aggregate real money demanded will

decrease

If central banks are not sterilizing and the home country has a balance of payments​ surplus, any associated

decrease in foreign central bank's claims on the home country implies a decreased foreign money

Suppose Home (H) imposes a tariff on imports from Foreign (F). All else​ equal, this action will cause the​ long-run real​ Home/Foreign exchange rate to​ ______ and the​ long-run nominal​ Home/Foreign exchange rate to​ ______

decrease; decrease

When the central bank buys foreign assets​ (and makes no other​ changes),

domestic money supply increases because central bank liabilities rise as well.

In the​ long-run, prices will fully adjust—they will decline proportionally to the change in the nominal money supply. ​ Therefore, in the​ long-run the interest rate will be

equal to the initial interest rate.

True or False: No permanent shock moves both AA and DD at the same​ time; they are separate

false

If a government initially has a balanced budget but then cuts​ taxes, it is running a deficit that it must somehow finance. Suppose people think the government will finance its deficit by printing the extra money it now needs to cover its expenditures. In this​ case, the tax cut will...

have an ambiguous effect on the exchange rate

A temporary fiscal expansion​ (with full​ employment) will

increase GDP

If the expected real interest rate in the United States is 9 percent per year while that in Europe is 3 percent per​ year, it can be anticipated that over the next year the real​ dollar/euro exchange rate will

increase​, resulting in a real depreciation of the dollar against the euro

In the current​ Post-Industrial economy, international trade in services​ (including banking and financial​ services)

is relatively small.

If the central​ bank's foreign assets​ fall, central bank

liabilities can rise or fall depending on the change in central bank domestic assets.

In the​ present, most of the exports from China are in

manufactured goods.

Under imperfect asset substitutability

sterilized intervention affects money supply.

The opportunity cost of money holdings is

the alternative interest income foregone from not holding some other asset.

According to the gravity​ model, a characteristic that tends to affect the probability of trade existing between any two countries is

the distance between them.

the volume effect is

the effect of a change in the real exchange rate on imports and exports

the value effect is

the effect of a change in the real exchange rate on the value of foreign imports in terms of domestic output

It is often asserted that exporters suffer when their home currencies appreciate in real terms against foreign currencies. This exporter​ "experience" stems from the fact​ that, ceteris paribus​,

the price of home goods relative to foreign goods rises when the home currency appreciates.

the current account will increase if

the real exchange rate depreciates or disposable income goes down

what happens in a domestic economy when the government imposes a temporary tariff on all imports?

there will be a rise in output and the domestic currency will appreciate

True or False: A permanent increase in government spending​ (starting at full​ employment) moves AA and DD in the​ short-run

true

True or False: A permanent increase in the money supply depreciates the currency

true

True or False: A permanent increase in the money supply​ (starting at full​ employment) moves AA and DD in the​ long-run

true

In claiming that​ "size matters," the gravity model asserts that there is a strong empirical relationship between the size of a​ country's economy and the

volume of its imports and exports.

GNP accounts avoid double counting by including only the value of final goods and services sold on the market. Should the measure of imports and exports used in the GNP accounts therefore be defined to include only imports and exports of final goods and services received from and sold to other​ countries?

​No, total values and imports and exports should be included in the calculation of the GNP.

Gross National Product represents the sum of the following expenditure​ categories:

​consumption, investment, government​ purchases, and the current account balance.

Which of the following temporary policies increases the current account and increases GDP (starting from full employment)?

Monetary expansion

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.

Suppose the return on a European bond is 9 percent per year. If we expect the US dollar to depreciate with respect to the euro by 18 percent in the next​ year, what is the expected dollar return on this European​ bond?

27 perfect

A sterilized foreign exchange intervention

always leaves the money supply unchanged.

Which of the Federal​ Reserve's measures of the monetary aggregates is composed of the most liquid​ assets?

M1

Which of the following is most plausible as an explanation for relative PPP holding better in the long run than in the short​ run?

- in the short run exchange rate fluctuations may be seen as temporary by trading firms. - prices tend to be less sticky in the long​ run, thus lessening any deviation from PPP. - it takes time for international trading firms to acquire​ and/or expand their​ "presence" in higher price markets.

A temporary decrease in government spending causes the current account to rise by a smaller amount than a permanent decrease in government spending does because the

- latter induces an increase in the expected future exchange rate - latter induces a depreciation of the currency's expected future value - former has no effect on expectations on future exchange rates

The government implements a permanent expansionary fiscal​ policy, which corresponds to an increase in US government spending or a fall in the US tax rates. What will happen to output and the exchange rate?

- output will not change - the exchange rate will fall

The government implements a temporary expansionary monetary​ policy, which corresponds to an increase in the US money supply. As a result, what will happen to output and the exchange rate in the short run?

- output will rise - the exchange rate will rise

what happens when a temporary tariff on all imports becomes permanent?

- the expected future exchange rate, E^e, will decrease - the DD curve will shift down the AA schedule - output will decrease - the domestic currency continues to appreciate

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?

1. Both public saving and private saving will rise. 2. Investment will remain the same.

A decrease in the money supply leads to (1) in the value of the U.S. dollar and (2) in the value of foreign currency. This in​ turn, leads to (3) in net exports and aggregate demand. A decrease in the money supply leads to (4) interest rates. ​This, in​ turn, leads to (5) in investment spending by firms and aggregate demand.

1. a increase 2. a decrease 3. a decrease 4. an increase 5. a decrease

As the result of a fall in real​ GNP, equilibrium in the money market will be at a (1) interest rate. Real money holdings will (2)

1. lower 2. remain unchanged

What is the effect of an increase in taxes under fixed exchange rates and perfect asset substitutability in the short​ run?

A decline in output and no change in interest rates.

What is the​ "arbitrage" opportunity in the foreign exchange​ market?

A difference between the exchange rates in different trading centers.

What is M1?

A monetary aggregate that includes currency in circulation and checkable deposits.

Based on purchasing power parity​ (PPP), which of the​ following, all else being​ equal, could lead to a​ long-run real appreciation of the U.S.​ dollar?

A rise in the growth rate of the U.S. GDP.

Among M1 and​ M2, which is the largest​ measure?

M2

If the U.S. dollar depreciates in terms of the​ Euro:

American goods would be cheaper for Europeans.

Which of the following is a correct prediction based on the PPP model of the exchange​ rates?

An increase in the U.S. interest rates leads to depreciation of the dollar.

Which combination of policies would achieve a lower interest rate while maintaining the fixed exchange​ rate?

An increase in the money supply and a sale of foreign assets

Which of the following assets is the most​ liquid? A. A​ traveler's check. B. An automobile. C. A U.S. savings bond. D. 50 shares of Microsoft stock.

A​ traveler's check

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.

Which of the following is NOT a function of​ money? A. Store of value. B. Capital used to produce goods and services. C. Medium of exchange. D. Unit of account.

Capital used to produce goods and services.

How does fiscal contraction affect the current account under a fixed exchange​ rate?

Current account improves as a result of a fiscal contraction.

Which of the following is NOT a valid explanation for the failure of the data to support PPP​ theory? A. Trade barriers. B. Transportation costs. C. Differences in price level measurements across countries. D. Differences in monetary policies across countries

D. Differences in monetary policies across countries

The difference between Gross National Product​ (GNP) and National Income is a trivial amount.

False. National income equals GNP less depreciation plus net unilateral transfers.

How do we distinguish in the model between the short run and the long​ run?

In the short run price level is​ fixed; in the long​ run, it is flexible.

What accounts for most of the activity in the foreign exchange​ market?

Interbank trading.

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.

What does PPP​ imply?

The real exchange rate is equal to 1.

How would you expect a fall in a​ country's population to alter its aggregate money demand​ function? Would it matter if the fall in population were due to a fall in the number of households or to a fall in the average size of a​ household?

There would be a decrease in money demand because there would be fewer transactions. The decrease in money demand would be larger if the decrease in population was due to a fall in the number of households.

If the central bank purchases​ assets, it will result in

am increase in the money supply

A managed floating exchange rate refers to

an exchange rate that is not​ pegged, but does not float freely.

The monetary approach to the exchange rate predicts that the dollar will appreciate in the long run​ if, ceteris paribus​,

US interest rate falls or European interest rate rises

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.

Which of the following assets is the least​ liquid? A. A share of publicly traded stock. B. Currency. C. A house. D. A​ three-month Treasury bill.

a house

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