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Questions and Answers of Economics

Suppose that the expected real interest rate in the United States is 9 percent per year while that in Europe is 3 percent per year. What do you expect to happen to the real dollar/euro exchange rate
In the short run of a model with sticky prices, a reduction in the money supply raises the nominal interest rate and appreciates the currency (Chapter 15). What happens to the expected real interest
Discuss the following statement: “When a change in a country’s nominal interest rate is caused by a rise in the expected real interest rate, the domestic currency appreciates. When the change is
Nominal interest rates are quoted at a variety of maturities, corresponding to different lengths of loans. For example, in late 2004 the U.S. government could take out ten-year loans at an annual
Continuing with the preceding problem, we can define short- and long-term real rates of interest. In all cases, the relevant real interest rate (annualized, that is, expressed in percent per year) is
Why might it be true that relative PPP holds better in the long run than the short run? (Think about how international trading firms might react to large and persistent cross border differences in
Can you think of any forces that might help bring about long-run PPP for nontradable goods? (It will help a bit here if you have understood the discussion in Chapter 5 of factor-price equalization.)
Suppose the government imposes a tariff on all imports. Use the DD-AA model to analyze the effects this measure would have on the economy. Analyze both temporary and permanent tariffs.
Imagine that Congress passes a constitutional amendment requiring the U.S. government to maintain a balanced budget at all times. Thus, if the government wishes to change government spending, it must
Suppose there is a permanent fall in private aggregate demand for a country’s output (a downward shift of the entire aggregate demand schedule). What is the effect on output? What government policy
Why does a temporary increase in government spending cause the current account to fall by a smaller amount than does a permanent increase in government spending?
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
You observe that a country’s currency depreciates while its current account worsens. What data might you look at to decide whether you are witnessing a J-curve effect? What other macroeconomic
A new government is elected and announces that once it is inaugurated, it will increase the money supply. Use the DD-AA model to study the economy’s response to this announcement.
How would you draw the DD-AA diagram when the current account’s response to exchange rate changes follows a J-curve? Use this modified diagram to examine the effects of temporary and permanent
What does the Marshall-Lerner condition look like if the country whose real exchange rate changes does not start out with a current account of zero?
Our model takes the price level P as given in the short run, but in reality the currency appreciation caused by a permanent fiscal expansion might cause P to fall a bit by lowering some import
Suppose that interest parity does not hold exactly, but that the true relationship is R = R* + (Ee - E)/E + ρ, where ρ is a term measuring the differential riskiness of domestic versus foreign
If an economy does not start out at full employment, is it still true that a permanent change in fiscal policy has no current effect on output?
The box on pages 450–451 suggested that even when a fiscal expansion is permanent, market actors might expect that, because of the resulting rise in the current account deficit, some part of the
See if you can retrace the steps in the five-step argument on pages 445–456 to show that a permanent fiscal expansion cannot cause output to fall.
The chapter’s discussion of “Inflation Bias and Other Problems of Policy Formulation” suggests (page 441, paragraph 4) that there may not really be any such thing as a permanent fiscal
If you compare low-inflation economies with economies in which inflation is high and very volatile, how might you expect the degree of exchange rate pass-through to differ, and why?
During the passage of the U.S. fiscal stimulus bill of February 2009, many members of Congress demanded “buy American” clauses, which would have prevented the government from spending money on
Show how an expansion in the central bank’s domestic assets ultimately affects its balance sheet under a fixed exchange rate. How are the central bank’s transactions in the foreign exchange
Do the exercises in the previous problem for an increase in government spending.
Describe the effects of an unexpected devaluation on the central bank’s balance sheet and on the balance of payments accounts.
Explain why a devaluation improves the current account in this chapter’s model.
The following paragraphs appeared in the New York Times on September 22, 1986. To keep the dollar from falling against the West German mark, the European central banks would have to sell marks and
Can you think of reasons why a government might willingly sacrifice some of its ability to use monetary policy so that it can have more stable exchange rates?
How does fiscal expansion affect the current account under a fixed exchange rate?
Explain why temporary and permanent fiscal expansions do not have different effects under fixed exchange rates, as they do under floating exchange rates.
Devaluation is often used by countries to improve their current accounts. Since the current account equals national saving less domestic investment, however (see Chapter 13), this improvement can
Using the DD-AA model, analyze the output and balance of payments effects of an import tariff under fixed exchange rates. What would happen if all countries in the world simultaneously tried to
When a central bank devalues after a balance of payments crisis, it usually gains foreign reserves. Can this financial inflow be explained using our model? What would happen if the market believed
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 in the form of U.S.
When domestic and foreign bonds are perfect substitutes, a central bank should be indifferent about using domestic or foreign assets to implement monetary policy. Discuss.
U.S. foreign exchange intervention is sometimes done by an Exchange Stabilization Fund, or ESF (a branch of the Treasury Department), which manages a portfolio of U.S. government and foreign currency
Use a diagram like Figure to explain how a central bank can alter the domestic interest rate, while holding the exchange rate fixed, under imperfect asset substitutability.
On page 467 in the text, we analyzed how the sale of $100 worth of its foreign assets affects the central bank’s balance sheet. The assumption in that example was that the buyer of the foreign
We observed in the text 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
In a three-country world, a central bank fixes one exchange rate but lets the others float. Can it use monetary policy to affect output? Can it fix both exchange rates?
In the Case Study on international reserves (pages 489–493), we asserted that except in the case of a reserve currency system, an attempt by all central banks simultaneously to raise their
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
Analyze the result of a permanent devaluation by an economy caught in a liquidity trap of the sort described in Chapter 17.
If you were in charge of macroeconomic policies in a small open economy, what qualitative effect would each of the following events have on your target for external balance?a. Large deposits of
Under a gold standard of the kind analyzed by Hume, describe how balance of payments equilibrium between two countries, A and B, would be restored after a transfer of income from B to A.
Despite the flaws of the pre-1914 gold standard, exchange rate changes were rare for the “core” countries (including the richer European countries and the United States). In contrast, such
Under a gold standard, countries may adopt excessively contractionary monetary policies as all countries scramble in vain for a larger share of the limited supply of world gold reserves. Can the same
A central bank that adopts a fixed exchange rate may sacrifice its autonomy in setting domestic monetary policy. It is sometimes argued that when this is the case, the central bank also gives up the
Suppose the central bank of a small country is faced by a rise in the world interest rate, R* what is the effect on its foreign reserve holdings? On its money supply? Can it offset either of these
How might restrictions on private financial account transactions alter the problem of attaining internal and external balance with a fixed exchange rate? What costs might such restrictions involve?
In 1961, Germany faced the dilemma of an external surplus and a booming economy. As a result, speculative capital flowed into Germany and the Germans felt obliged to revalue their currency (rather
You are an economic adviser to the government of China in 2008. The country has a current account surplus and is facing gathering inflationary pressures.a. Show the location of the Chinese economy on
Use the DD-AA model to examine the effects of a one-time rise in the foreign price level, P* If the expected future exchange rate Ee falls immediately in proportion to P* (in line with PPP), show
If the foreign inflation rate rises permanently, would you expect a floating exchange rate to insulate the domestic economy in the short run? What would happen in the long run? In answering the
Imagine that domestic and foreign currency bonds are imperfect substitutes and that investors suddenly shift their demand toward foreign currency bonds, raising the risk premium on domestic assets
The fifth Case Study (pages 538–544) discussed the big global imbalances of the 2000s and suggested that one can analyze factors determining world real interest rates in terms of the balance
The chapter suggested that because large increases in oil prices transfer income to countries that cannot rapidly increase their consumption or investment and therefore must save their windfalls,
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
Why might EMS provisions for the extension of central bank credits from strong- to weak-currency members have increased the stability of EMS exchange rates?
In the EMS before September 1992, the Italian lira/DM exchange rate could fluctuate by up to 2.25 percent up or down. Assume that the lira/DM central parity and band were set in this way and could
Continue with the last question. Imagine that in Italy, the interest rate on five-year government bonds was 11 percent per annum and that in Germany, the rate on five-year government bonds was 8
Do your answers to the last two questions require an assumption that interest rates and expected exchange rate changes are linked by interest parity? Why or why not?
Suppose that soon after Norway pegs to the euro, EMU benefits from a favorable shift in the world demand for non-Norwegian EMU exports. What happens to the exchange rate of the Norwegian krone
Use the GG-LL diagram to show how an increase in the size and frequency of unexpected shifts in a country’s money demand function affects the level of economic integration with a currency area at
During the speculative pressure on the EMS exchange rate mechanism (ERM) shortly before Britain allowed the pound to float in September 1992, the Economist, a London weekly news magazine, opined as
Imagine that the EMS had become a monetary union with a single currency but that it had created no European Central Bank to manage this currency. Imagine instead that the task had been left to the
Why would the failure to create a unified EU labor market be particularly harmful to the prospects for a smoothly functioning EMU?
Britain belongs to the EU, but it has not yet adopted the euro, and fierce debate rages over the issue. a. Find macro data on the British economy’s performance since 1998 (inflation, unemployment,
Movements in the euro’s external exchange rate can be seen as goods-market shocks that have asymmetric effects on different euro zone members. When the euro appreciated against China’s currency
In the United States€™ currency union, we seem never to worry if a state has a big current account deficit. Have you ever seen such data in the newspaper? Can you even find the data in any
Which portfolio is better diversified, one that contains stock in a dental supply company and a candy company or one that contains stock in a dental supply company and a dairy product company?
Imagine a world of two countries in which the only causes of fluctuations in stock prices are unexpected shifts in monetary policies. Under which exchange rate regime would the gains from
When a U.S. bank accepts a deposit from one of its foreign branches, that deposit is subject to the Fed’s reserve requirements. Similarly, Fed reserve requirements are imposed on any loan from a
The Swiss economist Alexander Swoboda has argued that the Eurodollar market’s early growth was fueled by the desire of banks outside the United States to appropriate some of the revenue the United
After the developing-country debt crisis began in 1982 (see the next chapter), U.S. bank regulators imposed tighter supervisory restrictions on the lending policies of American banks and their
Why might growing securitization make it harder for bank supervisors to keep track of risks to the financial system?
Return to the example in the text of the two countries that produce random amounts of kiwi fruit and can trade claims on that fruit. Suppose the two countries also produce raspberries that spoil if
Sometimes it is claimed that the international equality of real interest rates is the most accurate barometer of international financial integration. Do you agree? Why or why not?
If you look at data on the website of the Bureau of Economic Analysis, you will see that between the end of 2003 and the end of 2007, the net foreign debt of the United States rose by far less than
In interpreting ratios such as those in Table one must be cautious about drawing the conclusion that diversification is rising as rapidly as the reported numbers rise. Suppose a Brazilian buys a U.S.
Can a government always collect more seigniorage simply by letting the money supply grow faster? Explain your answer.
Assume that a country’s inflation rate was 100 percent per year in both 1990 and 2000 but that inflation was falling in the first year and rising in the second. Other things equal, in which year
In the early 1980s, Brazil’s government, through an average inflation rate of 147 percent per year, got only 1.0 percent of output as seigniorage, while Sierra Leone’s government got 2.4 percent
Suppose an economy open to international capital movements has a crawling peg exchange rate under which its currency is pegged at each moment but is continuously devalued at a rate of 10 percent per
The external debt buildup of some developing countries (such as Argentina) in the 1970s was due, in part, to (legal or illegal) capital flight in the face of expected currency devaluation.
Much developing-country borrowing during the 1970s was carried out by state-owned companies. In some of these countries, there have been moves to privatize the economy by selling state companies to
How might a developing country’s decision to reduce trade restrictions such as import tariffs affect its ability to borrow in the world capital market?
Why would Argentina have to give the United States seigniorage if it gave up its peso and completely dollarized its economy? How would you measure the size of Argentina’s sacrifice of seigniorage?
Early studies of the economic convergence hypothesis, which looked at data for a group of currently industrialized countries, found that those that were relatively poor a century ago subsequently
Some critics of the adoption of fixed exchange rates by emerging market economies argue that these exchange rates create a kind of moral hazard. Do you agree?
In some emerging market economies, not only are debt obligations to foreigners denominated in dollars, but so are many of the economies’ internal debts, that is, debts of one domestic resident to
What factors explain why the world’s trading nations have become increasingly interdependent, from an economic and political viewpoint, during the post-World War II era?
What are some of the major arguments for and against an open trading system?
What significance does growing economic interdependence have for a country like the United States?
What factors influence the rate of growth in the volume of world trade?
Identify the major fallacies of international trade.
What is meant by international competitiveness? How does this concept apply to a firm, an industry, and a nation?
What do researchers have to say about the relation between a firm’s productivity and exposure to global competition?

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