Economics 446/546
Mid-term Exam
B. Daniel
March 11, 2011
Name_________________
Use the economic models we have studied in class to answer four of the following five
questions. State whether each part of the statement is True, False, or neither, and
explain the reasons for your answers. Use fully-labeled graphs and equations in your
explanations, but be sure to include words as well. Credit for each question depends
entirely on the quality of your explanations and graphs. Graphs and equations required
for full credit are given in parentheses. Always begin in a long-run equilibrium with full
employment output and current account balance.
1. Bernanke has stated that expansionary monetary policy is not designed to
depreciate the dollar. In fact, expansionary monetary policy will not affect the
value of the dollar (nominal exchange rate), the real exchange rate, or the current
account in the short-run, but it will have effects on all these variables in the longrun due to monetary neutrality. (short-run and long-run AA-DD-XX graph for
simple model, definition of monetary neutrality)
2. Assume that foreign countries impose a tariff on US goods. This will increase the
real exchange rate, thereby increasing the expected future value of the nominal
exchange rate. (supply-demand graph for real exchange rate and equation for
long-run value of real exchange rate). It will also create a current account deficit
in the US in the short-run, but not in the long-run, and reduce domestic output.
(short-run and long-run AA-DD-XX graph for simple model)
3. The US experiences an increase in expected future productivity. No change in
productivity occurs today. This reduces the long-run real exchange rate (graph for
real exchange rate) and increases the long-run value for full employment output.
The fall in the real exchange rate causes a fall in the expected future value of the
nominal exchange rate (equation for long-run value of nominal exchange rate). In
the extended model, there are no effects on any variables in the short-run, except
for the current account, since the shock will not occur until next period. (AA-DDXX curves for extended model, short-run only).
4. Foreign countries experience a transitory fall in government spending, creating a
transitory fall in foreign income. This depreciates the dollar and increases
domestic output and the current account in the short-run. (AA-DD-XX curves for
extended model, short-run only)
5. The European central bank has announced that it plans to raise interest rates next
month. To raise interest rates, they must reduce the money supply. (graph of
foreign money market equilibrium) This policy will cause the expected value of
the future exchange rate for the US to rise (depreciate). Considering this effect on
Ee , the contractionary foreign monetary policy creates a US recession and current
account deficit. (short-run AA-DD-XX curves in simple model)