Question 1
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.
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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 RLF
6. 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.
9. 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.
Question 2
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 RLF
17. 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.
19. 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.
28. 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.
Question 3
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 RLF
33. 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.
35. 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:
An increase in the real GDP (Gross Domestic Product) intends to enhance the level of imports that then reduces NE (Net Export). This in turn motivates domestic currency.
On rise of real GDP, national population has incremented income that they use to buy more of foreign products and services. This enhances the level of imports. Substantial increment in the level of imports leads to reduction in the net exports. With the rise in the need for foreign exchange, the rate of foreign exchange results in the emergence of excessive demand situation. The currency appreciation at the domestic level is indicated by a fall within the exchange rate from e* to e1. In the given graph, fe indicates foreign exchange.
Answer 2:
An increase in price level (PI) results in the decrease of exports that in turn enhances the net export. This again appreciates domestic currency.
With the rise in the price level of economy, demands of domestic products within the foreign market decreases. Now, export is termed as the sale of such domestic products into the foreign market. People in the foreign market consider the domestic products to be comparatively expensive and this reduces the level of export. The subsequent downfall of export results in the promotion of domestic currency (Mehr Export, weniger Import, 2014). The rate of exchange slides down from e* to e1. It results in the situation generating excessive demand within the economy. The enhanced price level at the current situation even leads rise in the level of imports since domestic population considers domestic products to be quite expensive as well as the process of foreign products to be comparatively lower than that of domestic products. So, they tend to purchase goods from the foreign marketers, thereby enhancing the level of imports. Increment in import level leads to increment within the demands for foreign exchange as well as reduction in the level of export leads to decrease in foreign exchange supply. Both the impacts cause a situation of excessive demand within the economy (Sabal, 2008).
Question 4
Answer 3:
When R is on a rise, capital is said to flow within the nation that results in the appreciation of domestic currency.
R is the domestic interest rate and when this R rises, investors in the foreign lands invest within the domestic bonds that result in the capital flow inside the country. Capital inflow causes enhanced supply of foreign exchange that leads to the decrease in the exchange rate. This decrement within the exchange rate is named as appreciation of domestic currency (Sharma, 2009).
Answer 4:
Capital markets possess greater mobility provided foreign capital intends to flow quickly in the country when interest rates that are risk free increase slightly above the available rates within other countries. With greater capital mobility, the value of R becomes less influential upon the exchange rates as compare to PI or RGDP (Valentine, 2012).
Answer 5:
The loan-able funds have demand that is inversely related to the interest rate, and hence the demand curve of such loan-able fund is negatively sloped. Supply of such loan-able funds is related positively with that of the interest rate that results in an upward sloping supply curve (Thompson, 2010). It is said to have achieved equilibrium at the point where the demand curve as well as the supply curve meet with each other. From this very equilibrium point, the equilibrium level of amount of loan-able funds as well as interest rate is derived.
The Central bank on engaging within the open market purchases, the supply of money increases within the economy. The increment of the money supply results in the downfall of domestic rate of interest. There is an increase in the supply of the real loan-able funds. The enhancement in the supply of real loan-able funds has been depicted by the shift of supply curve rightwards to SS1 that results in the fall of interest rate. The increase in the open market purchases causes the supply of RLF to increase that leads in the fall of R. This would decrease the exchange rate. Since the domestic interest rate is lower, the respective domestic economic agents would reduce their holdings of domestic bonds as well as they would also increase the foreign bonds holding as return earning from foreign bonds in quite high as compared to that earned from all domestic bonds. All investors would tend to sell off their respective domestic bonds as well as buy foreign bonds.
Answer 6:
the purchases of open market would increase supply of RLF that leads to the fall of R. the government buying of the open market leads to the supply of finance within the economy to enhance. This enhances the supplying of real loan-able funds. It reduces the interest rate.
Answer 7:
Low rate of real interest promotes households to borrow for financial purchases so that C rises. Likewise, low R promotes companies to buy new capital equipment and thus I rise. With low rate of interest the households easily borrow so as to finance all consumption. However, the investment as well as interest rate is related negatively. Low rate of interest leads in the rise of investment level.
Question 5
Answer 8:
On decrease of R within the real loan-able funds market, investment level rises as rate of interest as well as investment are related negatively. The corresponding rise in the investment level leads to overall increase in the aggregate demand. Increase in the aggregate demand curve is reflected by the shifting of the AD curve towards right. This rightward shift of the AD curve leads in the rise of price as well as output level.
As rate of interest lowers, investment level increases indeed. This causes an increment within the level of aggregate demand. Rise in the level of aggregate demand has been reflected by the right shift of the AD curve from AD1. The shift leads in the enhancement of the extent of real GDP from the position of Y* to Y1. There is also a simultaneous rise in the price level from P* to P1.
Answer 9:
PI increases and the real GDP rises. With the shifting of the AD curve towards the right side on account of rise in investment, there is a rise in the price level. Also, real GDP rises.
Answer 10:
A slight change in real GDP results in the increase of imports, simultaneous decrease in the net export, and depreciation in the domestic currency.
It is observed that the real GDP actually rises. An increment in the real GDP shows that domestic individuals possess increased income to buy foreign goods. This enhances the level of import. Net export is deemed to be the variance amidst exports as well as imports. With the rise of imports there is decrease in net exports. The overall demands for foreign exchange rely upon the import level. With the increase in the imports, the net demand for foreign exchange rises. The respective rise in demand for foreign exchange results in an increase in rate of foreign exchange. The increment of rate of foreign exchange is termed as depreciation.
Answer 11:
Any sort of change in the position of PI results in the fall of exports that result in the corresponding decrease in the net export.
As referred to in the above situation, it is observed that an increment exists in the price level that refers to the concept of domestic products becoming more and more expensive for the foreigners. This lowers the extent of exports. Since net exports is the distinction amidst exports as well as imports, any fall in exports results in fall of net exports.
Answer 12:
A change is R leads to the flowing out of foreign money from the nation. This leads to the depreciation of domestic currency.
Since the domestic interest rate is low, national or international investors prefer increasing their level of investment upon foreign bonds that provides increased return as compared to that of the domestic return. This leads to the flowing out of the capital from the nation. A situation also arises of excess demand for foreign exchange that drives the rate of exchange as well as domestic currency starts depreciating.
Question 6
Answer 13:
The cohesive effect of alterations in R, RGDP and PI results in the depreciation of domestic currency.
Answer 14:
Any depreciation in the domestic currency would intend to enhance exports as well as net export. However, alterations in RGDP as well as PI would increase the net export. The net result would be a rise in the net export.
On increase in the rate of exchange, all domestic manufacturers consider it to be profitable to sell products across borders. By this approach, exporting of domestic goods to foreign lands would increase. This leads to an increment in net export (NE).
Answer 15:
Net export will tend to help the goal of enhancing the nation’s economy.
The overall demand for funds that are loan-able is inversely proportional to the interest rate, and hence the corresponding demand curve of such loan-able funds is sloping negatively. The supply of such funds is related positively to the interest rate that leads to an upward rising sloping supply curve. It is said to have obtained equilibrium at the point where demand curve as well as supply curve meet and cross each other. From this point of equilibrium, one can derive the equilibrium level of amount of loan-able funds as well as interest rate.
Once the expenditure of government rises, the interest rate within the market increase as well as the corresponding supply of loan-able funds declines. It is reflected by the shifting of supply curve to the left side if real loan-able funds. On decrease of supply of real loan-able funds as well as shifting of supply curve leftward, the marker interest rate increases as well as supply of such funds declines. This is reflected by the direction of arrows.
Answer 17:
Any government borrowing results in rising of R and declining of RLF.
Answer 18:
On rising of government expense G r falling of taxes T, an increment takes place in AD as well as shifting of the curve rightward. It results in both price level as well as real GDP to rise.
When the variable G rises or T declines, there is a shift if the AD curve towards the right side of AD2, and so price level P* increases to P2 with corresponding rise of real GDP Y* to Y2. However, this enhances the deficit if the budget within the economy that the treasury usually finances with borrowed funds. The borrowed funds results in the increase of such loan-able funds that in turn results in the rise of interest rate. The increased rate of interest results in the flowing of foreign capital into the economy that leads to the depreciation of domestic currency. This drives down the AD2 to AD3 and that AS curves shifts up from AS to AS1. The real GDP shifts from Y* to Y2 and then falls down to Y3. The overall effect of the expansionary fiscal policy enhances the real GDP.
Answer 19:
PI rises as well as RGDP enhances.
Question 7
Answer 20:
A change within RGDP results in the increase of imports and decrease of net exports.
It has been observed that the real GDP has incremented. The rise in real GDP implied that domestic people possess increased income to make more foreign purchases. It leads enhancement in imports. Net export is the difference amidst exports as well as imports. The level of net export decreases with increase in imports. Foreign exchange demands rely upon the import level. As imports incremented, foreign exchange demands also increased (Eraker, 2001). This led to a rise in the rate of foreign exchange. The rise of foreign exchange rate is called depreciation.
Answer 21:
Any change in PI results in falling of export level that increases the net export.
From the mentioned situation above, it is identified that price level has enhanced that refers to the more expensiveness of the domestic goods fir foreigners. This declines export level. Since, net export refers to the difference amidst exports as well as imports, decline in exports leads to decline in net export.
Answer 22:
The combined impact of PI as well as RGDP upon net export leads to the domestic currency to appreciate.
Answer 23:
The alteration of R leads foreign money to flow within the nation. This causes the domestic currency to appreciate.
Answer 24:
The impacts of R contradict those of PI as well as RGDP. If capital mobility is high, the domestic currency will depreciate (Dutertre-Le Poncin and Caix, 2008).
Answer 25:
If the capital mobility is higher as well as the domestic currency appreciates, net export will decline. This will counter the goal of enhancing the national economy.
Answer 26:
In an economy having free trade as well as free flow of foreign capital, expansionary fiscal policy would be less effective than that of a nation whose closed economy has few foreign influences (FLIFEL, 2013).
Answer 27:
When the Central bank starts expansionary financial policy based on pegged exchange rate policy, the effects upon the foreign exchange market is in effective. However, this policy results import of domestic nation to increase as population possess increased money to buy gods from foreign lands (Hannah, 2008). The import of domestic nation is the export of foreign nation that means that increment in domestic import shows the rise of export of foreign nation. It shows the enhancement of domestic currency supply within the market of foreign exchange. The rate of exchange needs to be lowered at the original position, thereby making the monetary policy to be ineffective since exchange rate has to be pegged.
The rise in supply of Peso in fact has been incremented but as the exchange rate is pegged, it should return to the original position by reducing the supply of Peso. So, it is seen that the financial policy is quite ineffective under the system of fixed rate of exchange.
Answer 28:
Due to the expansionary financial policy of the central bank, the peso would depreciate.
Answer 29:
Question 8
For maintaining the fixed exchange rate, the bank should buy dollars.
Answer 30:
The actions of the central bank to manage the fixed exchange rate would reverse original expansionary financial policy (Dukes, 2006).
Answer 31:
Monetary policy having fixed exchange rates is quite ineffective.
Answer 32:
When fund is borrowed by the treasure for financing all deficits led by the expansionary monetary policy, there exists an increment in demand of real loan-able funds within the market that leads to the increase in the real rate of interest.
For financing all governmental deficits, it is a norm for the treasure to borrow funds that would increase the overall demands of real loan-able funds that is reflected by the shifting of the demand curve rightward of the loan-able funds (Chisăgiu, 2012). The right shift leads the real rate of interest to increase as well as the amount of real loan-able funds also rises. The shift of demand curve rightward has been shown by the arrow directed towards DD1.
Answer 33:
The government borrows results in R as well as RLF to rise.
Answer 34:
When G (government spending) rises or the T (taxes) falls, then there is a rise in the AD and the curve shifts to the right. This causes the both the price level and the real GDP to rise.
When G increases or T declines, the AD curve moves right to AD2 as a result the price level P* becomes P2 and the level of real GDP Y* becomes Y2. As the expansionary monetary policy leads the government deficit to rise, the treasury borrows funds that increase the domestic rate of interest. The increase in the domestic interest rate attracts adequate foreign capital creating an upward pressure upon the exchange rate (Magdalinos and Kandilorou, 2001). But since exchange rate is fixed, the money supply should be increased that causes an extra increase in the AD from AD2 to AD3. This leads to the overall enhancement in the real GDP initially from Y* to Y2 and then from Y2 to Y3.
Answer 35:
PI rises as well as RGDP increases.
On analyzing the situation, it is inferred that an expansionary monetary policy rises the real GDP as well as price as the AD curve shifts right but on account of fixed exchange rate, the money supply was enhanced that leads to further shift in the AD curve. This further increases the level of real GDP. As the AD curve shifts right, the price level gets increases (Venezuela plans to import and export gas, 2006).
Answer 36:
The change in RGDP results imports to increase as well as net export to decrease.
It is observed that the real GDP has increased. The rise in the real GDP shows the domestic individuals possess increased income for making foreign purchases. This leads imports torise. Now net export is the difference between the exports as well as imports. So increase in imports decreases the level of net exports. The demand for foreign exchange relies upon the import level. As imports increased, demand for foreign exchange has increased (Weale, 2002). The increase in demand for foreign exchange results in increase in the rate foreign exchange.
Answer 37:
The change in PI makes exports to fall that leads net expert to decrease.
Answer 38:
The joint effect of PI as well as RGDP upon NE leads the domestic currency to appreciate.
Answer 39:
The alteration in R makes foreign money to flow within nation. It causes the domestic currency to appreciate.
Answer 40:
The effect of R contradicts those of PI as well as RGDP. If capital mobility is low, the domestic currency would appreciate.
Answer 41:
If domestic currency declines, the central bank should purchase pesos for maintaining the fixed exchange rate. This effect will counter the goal of stimulating the nation’s economy (Wende, 2009).
Answer 42:
If capital mobility is high, the domestic currency will appreciate. The central bank must purchase dollars to maintain the fixed exchange rate. This effect will support the goal of stimulating the nation’s economy.
Answer 43:
The impossible trinity is a trilemma existing in international economics. It denotes three things that impossible to occur simultaneously. A fixed exchange rate Free movement of capital (capital controls are absent) and An independent monetary policy. The theory may be considered to be both based on hypothesis and also on the findings from studies where governments failed constantly for pursuing all the goals simultaneously.
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