Embry mgmt673 week 8 problem set

| October 22, 2018

In the 3-sector model, analyzing the effect of an economic shock is most complex in the Foreign Exchange sector because 3 variables must be analyzed separately and then sometimes jointly. A change in the RDGP primarily affects imports whereas a change in PI mostly affects exports. A change in R influences foreign capital flow into or out of the nation’s economy. The foreign exchange effects can be analyzed graphically as in Marthinsen; however, both the supply and demand curves usually shift which can be confusing. You may find it easier to determine whether the domestic currency will appreciate or depreciate directly by-passing the graphical analysis. Problems 1 through 3 take this approach.For each choice in parentheses, highlight the correct answer. 1. A rise in RGDP tends to (increase or decrease) imports which then (increases or decreases)NE and, this in turn, (appreciates, depreciates) the domestic currency. 2. A rise in PI leads to a (increase or decrease) in exports which (increases or decreases) NE. This then leads to (appreciation or depreciation) of the domestic currency. 3. If R rises, capital flows (into or out of) the nation which causes an (appreciation or depreciation) of the domestic currency.4. Capital markets have high mobility if foreign capital tends to flow rapidly into the nation when real risk-free interest rates rise slightly above the rates available in other nations. With high capital mobility, R tends to be (more or less) influential on exchange rates than PI and RGDP.For problems 5 through 15, assume the central bank engages in aggressive open market purchases in an effort to stimulate the domestic economy. The nation has flexible exchange rates and the central bank does not intervene in the foreign exchange markets.5. Show the shift in the supply or demand for RLF by inserting a new curve. Insert arrows to show the change in R and RLFSDRSRLF/time period6. The open market purchases (increase or decrease) the supply of RLF which causes R to (rise or fall).7. Lower real interest rate encourages households to borrow to finance purchases, so the C (rises or falls). Similarly, lower R encourages firms to purchase new capital equipment and I (rises or falls).8. Show the shift in AS or AD in the real goods market as a result of the change in R in the real loanable funds market. Insert arrows to show the change in PI and RGDP.ASADPISRGDP/time period9. PI (rises or falls) and RGDP (increases or decreases).10. The change in RGDP causes imports to (increase or decrease), NE to (increase or decrease), and domestic currency to (appreciate or depreciate). 11. The change in PI causes exports to (rise or fall) which leads NE to (increase or decrease).12. The change in R causes foreign money to flow (into or out of) the nation. This causes the domestic currency to (appreciate or depreciate).13. The combined effect of changes in R, PI and RGDP causes the domestic currency to (appreciate or depreciate).14. The depreciation of the domestic currency will tend to (increase or decrease) exports and NE but the changes in PI and RGDP will (increase or decrease) NE. The net result will be an (increase or decrease) in NE.15. NE will tend to (support or oppose) the goal of stimulating the nation’s economy.For problems 16 through 26, the national government increases spending and lowers taxes in an effort to stimulate the nation’s economy. The budget deficit is increased, so the treasury borrows funds to finance the higher deficit. The country has flexible exchange rates and central bank does not intervene in the foreign exchange market.16. Show the shift in the supply or demand for RLF by inserting a new curve. Insert arrows to show the change in R and RLFSDRSRLF/time period17. The government borrowing causes R to (rise or fall) and RLF to (rise or fall).18. Show the shift in AS or AD in the real goods market as a result of the changes in G and T. Insert arrows to show the change in PI and RGDP.ASADPISRGDP/time period19. PI (rises or falls) and RGDP (increases or decreases).20. The change in RGDP causes imports to (increase or decrease) and NE to (increase or decrease). 21. The change in PI causes exports to (rise or fall) which leads NE to (increase or decrease).22. The combined effect of PI and RGDP on NE causes the domestic currency to (appreciate or depreciate).23. The change in R causes foreign money to (into or out of) the nation. This causes the domestic currency to (appreciate or depreciate).24. The effects of R oppose those of PI and RGDP. If capital mobility is (high or low), the domestic currency will (appreciate or depreciate). 25. If the capital mobility is high and the domestic currency appreciates, NE will fall. This effect will (support or counter) the goal of stimulating the nation’s economy.26. In an economy with free trade and free flow of foreign capital, expansionary fiscal policy will tend to be (more or less) effective than for a country whose closed economy has few foreign influences.For problems 27 through 31, assume the central bank engages in aggressive open market purchases in an effort to stimulate the domestic economy. The nation has a pegged its exchange rate to the US dollar which the central bank maintains by aggressive intervention in the foreign exchange markets. The domestic currency is the peso. The foreign exchange rate is initially in equilibrium at the pegged rate. 27. Show the shift in the supply or demand for pesos in the foreign exchange market as a result of the expansionary monetary policy. Insert arrows to show the change in exchange rate and pesos traded per period of time.SD$/pesoPesos/period of time28. As a result of the central bank’s expansionary monetary policy (open market purchases), the peso will (appreciate or depreciate).29. In order to maintain the fixed exchange rate, the central bank must purchase (dollars or pesos).30. The central bank’s actions to maintain the fixed exchange rate will (enforce or reverse) its initial expansionary monetary policy.31. Monetary policy with fixed exchange rates is highly (effective or ineffective).For problems 32 through 42, the national government increases spending and lowers taxes in an effort to raise RGDP and lower the unemployment rate. However, the budget deficit is increased, so the treasury borrows funds to finance the higher deficit. The country has fixed exchange rates with the US dollar which the central bank maintains through aggressive intervention in the foreign exchange market.32. Show the shift in the supply or demand for RLF by inserting a new curve. Insert arrows to show the change in R and RLFSDRSRLF/time period33. The government borrowing causes R and RLF to (rise or fall).34. Show the shift in AS or AD in the real goods market as a result of the change in G and T. Insert arrows to show the change in PI and RGDP.ASADPISRGDP/time period35. PI (rises or falls) and RGDP (increases or decreases).36. The change in RGDP causes imports to (increase or decrease) and NE to (increase or decrease). 37. The change in PI causes exports to (rise or fall) which leads NE to (increase or decrease).38. The combined effect of PI and RGDP on NE causes the domestic currency to (appreciate or depreciate).39. The change in R causes foreign money to flow (into or out of) the nation. This causes the domestic currency to (appreciate or depreciate).40. The effect of R opposes those of PI and RGDP. If capital mobility is low, the domestic currency will (appreciate or depreciate). 41. If the domestic currency depreciates, the central bank must purchase (dollars or pesos) to maintain the fixed exchange rate. This effect will (support or counter) the goal of stimulating the nation’s economy.42. If capital mobility is high, the domestic currency will (appreciate or depreciate). The central bank must purchase (dollars or pesos) to maintain the fixed exchange rate. This effect will (support or counter) the goal of stimulating the nation’s economy. 43. The Impossible Trinity holds that a nation can achieve any 2 of 3 goals. List the 3 goals:

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