宏观经济学习题及答案(19)

Exchange Rates, Part 2Multiple Choice Questions1.An increase in the domestic real interest rate will tend to cause, other things the same:a. A depreciation of the domestic currency.b.An appreciation of the domestic currency.c.An increase in the demand for domestic goods and services.d.An increase in demand for foreign currencies.2.An appreciation of the domestic currency can be caused by:a. A decrease in the domestic interest rate.b.The expectation of a decrease in the value of the domestic currency.c.An increase in the domestic interest rate and expectation of an increase in the value of thedomestic currency.d.An increase in the domestic interest rate and the expectation of a decrease in the value of thedomestic currency.3.Other things the same, if participants in foreign exchange markets come to expect an increase in the valueof the U.S. dollar:a.The actual value of the U.S. dollar will rise.b.The actual value of the U.S. dollar will fall.c.The actual value of the U.S. dollar will not be affected.d.One cannot predict the movement of the U.S. dollar in the future.4. A rightward shift in the demand curve for domestic assets can be caused by:a. A decrease in the domestic real interest rate.b.An increase in the domestic real interest rate.c. A leftward shift in the supply curve for domestic assets.d. A rightward shift in the supply curve for domestic assets.Exchange Rates, Part 25.An increase in the foreign real interest rate will tend to cause, other things the same:a.An increase in the demand for dollars.b.Individuals to hold fewer dollar assets.c.An appreciation in the value of the U.S. dollar.d.An increase in the return on dollar assets relative to foreign assets.6. A rise in the expected future exchange rate will tend to cause, other things the same:a. A depreciation of the domestic currency.b.An appreciation of the domestic currency .c.No effect on the value of the U.S. dollar.d.No effect on the value of the U.S. dollar in the short-run.7.An increase in the value of the U.S. dollar will tend to cause, other things the same:a.An increase in the volume of U.S. exports.b.An increase in the volume of U.S. imports.c. A decrease in the volume of U.S. exports and imports.d.An increase in the volume of U.S exports and imports.8.Suppose the U.S. dollar depreciates, and there is no change in monetary policy. Which of the following is acorrect description of the short-run consequences?a.Output, inflation, and the real interest rate have all increased.b.Output and inflation are higher, while the real interest rate has fallen.c.Output, inflation, and the real interest rate have returned to their original values.d.Output and inflation have returned to their original values, while the real interest rate is increased.9.In the short run, who tends to benefit from a decrease in the exchange rate?a.Foreign producers.b.Domestic consumers.c.Domestic producers.d.Owners of domestic-currency assets.Exchange Rates, Part 210. A decline in the value of net exports in the U.S. is most likely to result from an increase in:a.U.S. exports.b.Foreign income.c.Foreign real interest rates.d.The value of the U.S. dollar.11.Central banks intervene directly in foreign exchange markets by buying and selling:a.Discount loans.b.Foreign currencies.c.Exports and imports.d.U.S. government debt.12. A foreign exchange intervention that lowers the exchange rate will also:a.Increase investment.b.Decrease the money supply.c.Increase the real interest rate.d.Decrease international reserves.13.The purchase of foreign currency by a central bank will tend to cause:a. A decrease in the domestic money supply.b. A decrease in the supply of domestic assets.c.An increase in the demand for domestic currency.d. A decrease in the relative expected return on domestic assets.14.Under a fixed exchange rate system, if an appreciation in the value of a country's currency develops, themonetary authorities must intervene by:a.Selling foreign exchange.b.Buying foreign exchange.c.Raising the foreign interest rate.d.Buying and selling the domestic currency.Exchange Rates, Part 215. A central bank with a fixed exchange rate must, in response to an interest rate decline in the anchor-currency economy:a.Revalue its currency.b.Sell the anchor currency.c.Convene a currency board.d.Purchase the anchor currency.16.One of the chief advantages of exchange rate pegging is that:a.It can be an effective means of reducing inflation.b.The currency can be used to promote export growth.c. A country is able to pursue an independent monetary policy over the course of the business cycle.d.It allows the monetary authorities to actively respond to the problems of inflation andunemployment.17.In many countries, an exchange-rate peg substitutes for:a.Capital controls.b.Speculative attacks.c.An export-oriented sector.d.Discretionary monetary policy.Discussion Questions1.What are the short-run effects on aggregate output and inflation when the domestic currency appreciates ordepreciates?Because appreciation of the domestic currency increases the real as well as the nominal exchangerate in the short run, it makes exports more expensive and imports less expensive. This causes netexports to decline and shifts the aggregate demand curve to the left. While the currency’s appreciation also shifts the short-run aggregate supply curve downward, because it makes importsless expensive and lowers the aggregate price level, this effect is typically smaller than the impact onaggregate demand. The overall impact, therefore, is that aggregate output and the inflation rate bothdecrease. Depreciation of the domestic currency has the opposite effect of raising both inflation andoutput.Exchange Rates, Part 22.Why do central banks intervene in foreign exchange markets? How do these interventions affect theirinternational reserves and exchange rates?Central banks intervene in foreign exchange markets to adjust their holdings of internationalreserves (foreign-currency denominated assets), influence exchange rates, or both. When a centralbank buys assets denominated in the domestic currency, it is selling some of its foreign-currencydenominated assets, and so its international reserves decline. Alternatively, a central bank that sellsassets denominated in the domestic currency is buying international reserves. The impact onexchange rates depends on whether the intervention is sterilized or unsterilized. An unsterilizedpurchase of domestic currency (sale of international reserves) reduces bank reserves, lowers themoney supply, and causes the domestic interest rate to rise, so the domestic currency appreciates.Conversely, an unsterilized sale of domestic currency (purchase of international reserves) increasesbank reserves and the money supply and reduces the domestic interest rate, so the domestic currencydepreciates. Sterilized interventions, however, do not affect exchange rates because the central bankoffsets them with open market operations that leave bank reserves unchanged.3.How do fixed, flexible, and managed (or dirty) float exchange rate regimes differ?In a fixed exchange rate regime, the value of one currency is pegged to another currency (called theanchor currency), and central banks intervene in foreign exchange markets to keep the exchangerate between the two currencies at this fixed value. In a floating exchange rate regime, there is nopreset exchange rate that central banks are trying to maintain. Instead, exchange rates aredetermined by supply and demand and, therefore, are allowed to “float” up or down depending on market forces. A managed or dirty float exchange rate regime is one in which central banksintervene as they see fit to influence exchange rates.Exchange Rates, Part 24.What happens in a fixed exchange rate regime if a currency is overvalued? What problem can this create?A currency is overvalued relative to another currency if the fixed exchange rate (par value of thecurrency) is higher than the equilibrium exchange rate between the two currencies in the foreignexchange market. To keep the exchange rate from falling to the equilibrium value, the central bankmust intervene to buy domestic currency by selling its international reserves. This is a problembecause sooner or later the central bank will exhaust its international reserves and be unable tomaintain the exchange rate for its currency at the par value. When this occurs, the currency must bedevalued, which means the fixed exchange rate is reset at a lower value. Anticipation that this mayoccur leads to speculative attacks on the currency in which speculators sell large quantities of thecurrency and drive its equilibrium market value lower, which puts more pressure on the centralbank’s international reserve position and hastens the expected devaluation.5.What is the policy trilemma?The policy trilemma is the reality that a country or monetary union cannot simultaneously have freecapital mobility, a fixed exchange rate for its currency, and an independent monetary policy. It canchoose any two of these policies but must give up the remaining one.6.What are the advantages and disadvantages of exchange rate pegging?Exchange-rate pegging helps keep inflation low and anchors inflation expectations in the peggingcountry to those in the anchor country. It replaces the pegging country’s monetary policy, which ma not have done a good job in the past of stabilizing the economy, with that of the anchor country.Exchange-rate pegging has racked up some successes at quickly reducing inflation expectations inemerging market countries. However, it also has some important disadvantages. The pegging countrycannot pursue an independent monetary policy, which severely impairs its ability to respond todomestic shocks that do not also hit the anchor country. It also exposes the pegging country to therisk of speculative attacks on its currency.Exchange Rates, Part 27.Brazil has announced the discovery of huge oil reserves that could potentially transform the country into abig oil exporter of oil.a.What would be the effect of the increase in revenue from oil exports on Brazil’s exchangAn increase in Brazilian net exports will result in an inflow of foreign currency. If thecentral bank of Brazil does not want to accumulate foreign assets, it will sell them and getBrazilian reals in exchange. This reduces Brazil’s money supply and increases domesticinterest rates. Alternatively, the inflow of foreign currency can create inflation and increasethe real exchange rate. These are just two reasons as to why Brazil’s exchange rate willincrease.b.How would this affect other Brazilian exports? Is this a desirable outcome for the country as awhole?Even if the oil exporting industry thrives in Brazil, it can potentially have negativeconsequences for other exporting industries if the Brazilian currency becomes moreexpensive (i.e., if the exchange rate increases). The more expensive currency makes exportsmore expensive, and other industries are severely affected. This effect is often referred to asthe “Dutch disease,” based on the experience of the Netherlands’ discovery of natural gasreserves in the 1960s. As this is clearly not a good prospect for the Brazilian economy,monetary authorities probably will try to minimize the effect of the foreign currency inflowon Brazil’s exchange rate.8.Explain why a central bank might want to intervene in the foreign exchange market to prevent an excessiveappreciation of its currency even if it previously stated that it would allow its currency to respond to supplyand demand conditions in the foreign exchange market.Even if a central bank adheres to a floating exchange rate regime (i.e., to allow its currency torespond to supply and demand conditions in the foreign exchange market), it might still haveincentives to intervene in the foreign exchange market. An excessive appreciation of its currency willhurt that country’s exports, as exports will become more expensive in terms of the foreign currency.Whenever a central bank allows excessive fluctuation in its exchange rate, part of the external sector(exporters or importers) will be hurt. Because countries have become increasingly interdependent,the external sector has increased in importance for almost every world economy, and therefore,exchange rate considerations are very important as well. Even though many countries state that theywill allow their currencies to float, most of them routinely intervene in the foreign exchange marketto avoid excessive fluctuations in the value of their currencies, effectively adhering to a system knownas “managed” or “dirty” float.Exchange Rates, Part 29.Assume that a country has pegged the value of its currency to another country’s currency and that tanchor country increases its interest rate. Describe the effects on the following:a.The export sector of the pegging country.An increase in the interest rate of the anchor country results in an overvaluation of thepegging currency. In addition to fears of a speculative attack, an overvalued currencyreduces net exports by making exports more expensive. Importing firms will benefit from astronger currency, and imports of capital goods may increase.b.Households’ net worth if the pegging country is forced to devalue its currency and most of itsdebts are denominated in the anchor country’s currency.One of the most interesting effects of devaluation experiences is the negative effect on the networth of households and firms whose debts were denominated in the foreign currency. Afterthe devaluation occurs, it will take more units of domestic currency to repay your debts. Thistype of consequence was common during many of the devaluation experiences described inthe textbook. In terms of the domestic currency, households’ and firms’ liabilities increaseovernight, while their assets remain at the same value. This constitutes yet one more reasonas to why it might be quite risky for a country to peg the value of its currency to anothercurrency.Analytical QuestionsThese questions should be answered based on the standard models of analysis developed in class.The information in the various parts of the question is sequential and cumulative.Econ 100B / UGBA 101B: Macroeconomic AnalysisPost Lecture #26 Exercise ANSWERSExchange Rates, Part 2b.In Year 1 the central bank engages in an open market purchase of government securities. Incorporatingonly this additional information, clearly and accurately show in your diagrams above what, if anything, happens to (1) economic output, (2) inflation, and (3) the exchange rate. These effects should be drawn in RED.c.Provide an economic explanation of what you have shown in your diagrams above. Discuss what, ifanything, happens to (1) economic output, (2) inflation, and (3) the exchange rate. Be sure to e xplain why these changes take place and what causes them.In Year 1, the central bank engages in an open market purchase of government securities, anexpansionary monetary policy. This increases the money supply and reduces the real policyinterest rate. This decrease in the real policy interest rate has three separate effects.First, a lower real policy interest rate reduces the cost of borrowing and increases theamount of borrowing. This increases planned expenditures and aggregate demand for anygiven inflation. This is represented by a rightward shift of the aggregate demand curve fromAD0 to AD1a. Economic output is higher for any given inflation.At the initial inflation of π0 there is now excess demand for goods and services in the economy.This causes inflation to increase from π0 to π1a along the short-run aggregate supply curveSRAS0(πe = π0) as economic output increases from Y0 to Y1a.Second, a lower real policy interest rate decreases the relative return to domestic currencydenominated assets. This is represented by a leftward shift of the demand curve for domesticcurrency denominated assets from D0 to D1. At the initial exchange rate of E0 there is nowexcess supply of domestic currency denominated assets in the foreign exchange market. Thisexcess supply causes the currency to depreciate from E0 to E1.This depreciation of the currency from E0 to E1 decreases the cost of domestic goodsexported to foreign residents who now buy more of them; as a result, exports increase. Thedepreciation of the currency from E0 to E1 also increases the cost of foreign goods importedfor domestic residents who now buy fewer of them; as a result, imports decrease. This causesnet exports, planned expenditures, and aggregate demand to increase for any given inflation.This is represented by a further rightward shift of the aggregate demand curve from AD1a toAD1. Economic output is higher for any given inflation.Third, this depreciation of the currency from E0 to E1 increases the cost of imported goods.This increases the cost of production for any given level of economic output. This isrepresented by an upward shift of the short-run aggregate supply curve from SRAS0(πe = π0)to SRAS1(πe = π0). Inflation is higher for any given level of economic output.At inflation of π1a there is now excess demand for goods and services in the economy. This causes inflation to increase from π1a to π1 along the short-run aggregate supply curve SRAS1(πe = π0) as economic output increases from Y1a to Y1.Exchange Rates, Part 2When these Year 1 effects are complete, the economy is in a new short-run equilibrium where:(1)Economic output has increased from Y0 to Y1,(2)Inflation has increased from π0 to π1, and(3)The exchange rate has depreciated from E0 to E1.Exchange Rates, Part 2d.Subsequent to the monetary policy change but still in Year 1, the government decides to peg theexchange rate at its initial (i.e., Year 0) level. Incorporating only this additional information, clearly and accurately show in your diagrams above what, if anything, happens to (1) economic output, (2) inflation, and (3) the exchange rate. These effects should be drawn in BLUE.e.Provide an economic explanation of what you have shown in your diagrams above. Discuss what, ifanything, happens to (1) economic output, (2) inflation, and (3) the exchange rate. Be sure to e xplain why these changes take place and what causes them. Also, be sure to e xplain exactly what the central bank must do in order to peg the exchange rate.In order to peg the exchange rate at its initial Year 0 level of E0, the central bank must intervene in the foreign exchange market, selling international reserves and buying its domestic currency.This decrease in the domestic money supply must be sufficient to increase the real policy interest rate to its original (i.e., Year 0) level, i.e., r2 = r0.The increase in the real interest rate has three separate effects:First, the higher real policy interest rate increases the relative return to domestic currencydenominated assets. This is represented by a rightward shift of the demand curve fordomestic currency denominated assets from D1 to D2 which must equal D0 if the exchange rate is fixed at its Year 0 level. At an exchange rate of E1 there is now excess demand fordomestic currency denominated assets in the foreign exchange market. This excess demandcauses the currency to appreciate from E1 to E2 which is equal to E0 if the exchange rate is fixed to its Year 0 level, i.e., E2 = E0.This appreciation of the currency from E1 to E2 increases the cost of domestic goodsexported to foreign residents who now buy fewer of them; as a result, exports decrease totheir original level. The appreciation of the currency from E1 to E2 also decreases the cost of foreign goods imported for domestic residents who now buy more of them; as a result,imports increase to their original level. This causes net exports, planned expenditures, andaggregate demand to decrease for any given inflation. This is represented by a rightwardshift of the aggregate demand curve from AD1 to AD2a which is equal to AD1a because now there has been no change in net exports.Second, the appreciation of the currency from E1 to E2 decreases the domestic cost ofimported goods. This decreases the cost of production for any given level of economicoutput. This is represented by a downward shift of the short-run aggregate supply curvefrom SRAS1(πe = π0) to SRAS2(πe = π0) which now equals SRAS0(πe = π0). Inflation is lowerfor any given level of economic output.At inflation of π1, the appreciation of the currency from E1 to E2 results in an excess supply of goods and services in the economy. This excess supply causes inflation to decline from π1 to π2a along the short-run aggregate supply curve SRAS2(πe = π0) as economic output decreases from Y1 to Y2a.Exchange Rates, Part 2Third, the higher real policy interest rate increases the cost of borrowing and decreases the amount of borrowing which reduces planned expenditures and aggregate demand. This isrepresented by a leftward shift of the aggregate demand curve from AD2a to AD 2 (which must equal AD0) because of the decrease in interest-sensitive consumption and investment spending, i.e., AD2 = AD0.At inflation of π2a, the higher real interest rate results in an excess supply of goods and services in the economy. This excess supply causes inflation to decline from π2a to π2 along the short-run aggregate supply curve SRAS2(πe = π0) as economic output decreases from Y2a to Y2 which must equal to Y0.When these Year 1 effects are complete, the economy is in a new short-run (and general) equilibrium where:(1)Economic output has decreased from Y1 to Y2 which is equal to Y0,(2)Inflation has decreased from π1 to π2 which is equal to π0, and(3)The exchange rate has appreciated from E1 to E2 which is equal to E0.Monetary policy is completely ineffective if the government pegs its exchange rate.Exchange Rates, Part 2b.Provide an e conomic explanation of what you have shown in your diagrams above.Country A is initially in general equilibrium with perfect capital mobility and a flexibleexchange rate. As a result, economic output is at potential output, i.e., Y0 = Y P, with inflation stable at π0 and the foreign exchange market is in equilibrium with the exchange rate at E0.Country B is also initially in general equilibrium with perfect capital mobility and a flexibleexchange rate. As a result, economic output is at potential output, i.e., Y0 = Y P, with inflation stable at π0 and the foreign exchange market is in equilibrium with the exchange rate at E0.With perfect capital mobility and a flexible exchange rate in both Country A and Country Bthe foreign exchange market is in equilibrium with an exchange rate of E0.15/19Exchange Rates, Part 2c.In Year 1, Country A experiences a sharp decline in business confidence. Incorporating only thisadditional information, clearly and accurately show in your diagrams above what, if anything,happens to both economies’ (1) economic output, (2) inflation, and (3) exchange rate. Theseeffects should be drawn in R ED.d.Provide an economic explanation of what you have shown in your diagrams above. Discusswhat, if anything, happens to both economies’ (1) economic output, (2) inflation, and (3) exchange rate. Be sure to explain why these changes take place and what causes them.When business confidence in Country A declines in Year 1, six events occur:First, the sharp decline in business confidence causes a decrease in autonomousinvestment, planned expenditures and aggregate demand. This is represented by aleftward shift in the aggregate demand curve from AD0 to AD1a. The decrease inaggregate demand causes a decline in economic output from Y0 to Y1a, resulting in anegative output gap. The negative output gap causes inflation to decline from π0 toπ1a along the short-run aggregate supply curve, SRAS0(πe = π0).Second, the decrease in inflation from π0 to π1a causes the central bank to decreasethe real interest rate according to the Taylor Principle, represented by a movementalong the monetary policy curve.Because the real interest rate declines, Country A’s currency denominated assetsare now relatively less attractive to Country B’s investors while Country B’scurrency denominated assets are now relatively more attractive to Country A’sinvestors. Because the foreign exchange market uses a direct quotation for CountryB’s currency, this causes an increase in the demand for Country B’s currencydenominated assets. This is represented by an upward shift of the demand curve forCountry B’s currency denominated assets from D B0 to D B1.Once this shift occurs, there is excess demand for Country B’s currencydenominated assets at the initial exchange rate E0. To return the foreign exchangemarket to equilibrium, Country B’s currency appreciates and Country A’s currencydepreciates from E0 to E1.Third, because of Country A’s currency depreciation, Country A’s exports are nowless expensive to Country B’s residents who buy more of them. In addition, CountryB’s exports are now more expensive to Country A’s residents who buy less of them.Country A’s net exports increase, represented by a rightward shift of Country A’aggregate demand curve from AD1a to AD1.Fourth, in addition, Country A’s currency depreciation increases the domesticcurrency costs of imports from Country B. This is a negative short-run aggregatesupply shock, represented by an upward shift of Country A’s short-run aggregatesupply curve from SRAS0(πe = π0) to SRAS1(πe = π0).16/19Exchange Rates, Part 2Fifth, because of Country B’s currency appreciation, Country B’s exports are nowmore expensive to Country A’s residents who buy less of them. In addition, CountryA’s exports are now less expensive to Country B’s residents who buy more of them.Country B’s net exports decrease, represented by a leftward shift of Country B’s aggregate demand curve from AD0 to AD1.Sixth, in addition, Country B’s currency appreciation decreases the domesticcurrency costs of imports from Country A. This is a positive short-run aggregatesupply shock, represented by a downward shift of Country B’s short-run aggregatesupply curve from SRAS0(πe = π0) to SRAS1(πe = π0).The net result of Country A’s decline in business confidence is that:1.Country A’s currency depreciates from E0 to E1, economic output falls from Y0to Y1, and inflation declines from π0 to π1.2.Country B’s currency appreciates from E0 to E1, economic output falls from Y0to Y1 and inflation declines from π0 to π1.17/19Exchange Rates, Part 2e.Subsequent to the decline in business confidence in Country A, but also in Year 1, Country Bdecides to fix the exchange rate with Country A at its initial (i.e., Year 0) value. Incorporatingonly this additional information, clearly and accurately show in your diagrams above what, ifanything, happens to both economies’ (1) economic output, (2) inflation, and (3) exchange rate.These effects should also be drawn in BLUE.f.Provide an economic explanation of what you have shown in your diagrams above. Discusswhat, if anything, happens to both economies’ (1) economic output, (2) inflation, and (3) exchange rate. Be sure to explain why these changes take place and what causes them.When Country B decides to fix its exchange rate after the events above but still in Year 1 atits initial Year 0 value, six events occur:First, Country B buys Country A’s currency in the foreign exchange market inexchange for its own currency. This increases Country B’s domestic money supplyat any given inflation, represented by a downward shift of the monetary policycurve. Country B’s real policy interest rate declines, making County B’s currencydenominated assets are now relatively less attractive to Country A’s investors. As aresult, the demand curve for Country B’s currency denominated assets shifts to theleft from D B1 to D B2. Because Country B is fixing its exchange rate at its initial valueof E0, D B2 = D B0 and Country B’s currency depreciates from E1 to E2 which equalsE0.Second, in Country B, the currency depreciation makes Country B’s exports lessexpensive to Country A’s residents who buy more of them. In addition, importsfrom Country A are now more expensive to Country B’s residents who buy less ofthem. As a result, net exports, planned expenditures, and aggregate demandincrease, represented by a rightward shift of Country B’s aggregate demand curvefrom AD1 to AD2a (which equals AD0).Third, because Country B’s real interest rate decreases, Country B’s real interestrate declines, causing an increase in borrowing, planned expenditures, andaggregate demand. This can be represented by a rightward shift of Country B’saggregate demand curve from AD2a to AD2.Fourth, Country B’s currency depreciation increases the domestic currency cost ofimports from Country A, resulting in a negative short-run aggregate supply shock.This is represented by an upward shift of Country B’s short-run aggregate supplycurve from SRAS1(πe =π0) to SRAS2(πe =π0). Because the exchange rate hasreturned to its initial value, i.e., E2 = E0, SRAS2(πe = π0) is identical to SRAS0(πe =π0), i.e., there has been no net shift of the SRAS.18/19。