International economics 13th Edition Robert J. Carbaugh - Solutions

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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 over the next year?
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 rate? Explain why the subsequent path of the real exchange rate satisfies the real interest parity
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 caused by a rise in expected inflation, the currency depreciates.”
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 interest rate of slightly over 4 percent, whereas the annual rate it paid on loans of only three
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 the annualized nominal interest rate at the maturity in question, less the annualized expected
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 the prices of a tradable good.)
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 always change taxes by the same amount, that is, ∆G = ∆T Does the constitutional amendment
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 response would you recommend?
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 extra money it now needs to cover its expenditures. Would you still expect the tax cut to cause a
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 change might bring about a currency depreciation coupled with a deterioration of the current account,
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 changes in monetary and fiscal policy.
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 prices. If P can fall slightly as a result of a permanent fiscal expansion, is it still true that there
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 deposits. Suppose a permanent rise in domestic government spending, by creating the prospect of future
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 initial currency appreciation is temporary. If so, how would this affect your view of the short-run
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 expansion. What do you think? How would these considerations affect the exchange rate and output effects of
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 imported goods. According to the analysis of this chapter, would U.S. government spending constrained
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 market reflected in the balance of payments accounts?
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 buy dollars, a procedure known as intervention. But the pool of currencies in the marketplace is
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 occur only if investment falls, saving rises, or both. How might devaluation affect national saving and
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 improve employment and the balance of payments by imposing tariffs?
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 that another devaluation would occur in the near future?
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. Treasury bills. Would the international monetary adjustment mechanism have been symmetric or
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 bonds. An ESF intervention to support the yen, for example, would take the form of a portfolio
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 assets paid in the form of domestic currency cash. Suppose instead that the buyer pays with a check
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 points (mentioned in footnote 17) produced such bands under a gold standard. (Typically those bands
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 international reserve holdings through open-market sales of domestic assets could have a contractionary
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? When it
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 uranium are discovered in the interior of your country.b. The world price of your main export good,
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 changes became frequent in the interwar period. Can you think of reasons for this contrast?
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 problem arise under a reserve currency standard when bonds denominated in different currencies are
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 ability to use monetary policy to combat the wage-price spiral. The argument goes like this:
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 effects through domestic open-market operations?
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 than to devalue it). Can you describe how such a “revaluation crisis” or “inflow attack” might
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 a diagram like Figureb. What would be your advice on how the authorities should move the renminbi's
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 that the exchange rate will also appreciate immediately in proportion to the rise in P* If the
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 latter question, pay attention to the long-run relationship between domestic and foreign nominal
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 (Chapter 18). Which exchange rate regime minimizes the effect on output—fixed or floating?
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 between the world demand for savings (in order to finance investment) and the world supply of savings
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, world real interest rates fall in the short run. Put together data on the U.S. real interest rate for
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. Show that this action would be
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 not be changed. What would have been the maximum possible difference between the interest rates on
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 percent per annum. What would have been the implications for the credibility of the current lira/DM
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 against noneuro currencies? How is Norway affected? How does the size of this effect depend on the volume
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 which the country will wish to join.
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 follows: The [British] government’s critics want lower interest rates, and think this would be
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 various national central banks, each of which was allowed to issue as much of the European currency as
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, real GDP growth) and compare these with euro zone data. b. What were nominal interest rates in
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 2007, which country suffered the greater fall in aggregate demand, Finland, which does not
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 U.S. government statistical sources? For example, one would guess that the state of Louisiana ran
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 international asset trade be greater, fixed or floating?
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 U.S. bank’s foreign branch to a U.S. resident, or on any asset purchase by the branch bank from its
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 States was collecting as issuer of the principal reserve currency. (This argument is made in The
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 subsidiaries. Over the 1980s, the share of U.S. banks in London banking activity declined. Can you suggest
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 shipped between countries and therefore are nontradable. How do you think this would affect the ratio
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 the sum of its current account deficits over those years. At the same time, the dollar depreciated.
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. international equity fund, which places its clients€™ money in Brazil€™s stock
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 was seigniorage revenue greater? (Assume that asset holders correctly anticipated the path of
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 through an inflation rate less than a third as high as Brazil’s. Can you think of differences in
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 year. How would the domestic nominal interest rate be related to the foreign nominal interest rate?
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. (Governments and central banks borrowed foreign currencies to prop up their exchange rates, and these funds
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 private owners. Would the countries have borrowed more or less if their economies had been privatized
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? (To complete this exercise, think through the actual steps Argentina would have to take to dollarize
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 grew more quickly. Is it valid to infer from this finding that the convergence hypothesis is true?
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 another. This phenomenon is sometimes called liability dollarization. How might liability
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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International economics 13th Edition Robert J. Carbaugh - Solutions

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