EXAM II, ECON 457
SPRING 2015
March 12, 2015
Each multiple choice question is worth four points.
NAME
UID
1. Using the Uncovered Interest Parity (UIP) equation, what would happen to the spot rate
for euros if the interest rate on U.S. dollar deposits rises ceteris paribus?
A) the spot rate to purchase euros would rise (dollar depreciation).
B) the spot rate to purchase euros would fall (dollar appreciation).
C) the spot rate to purchase euros would be unchanged.
D) the U.S. Federal Reserve would have to raise U.S. short-term interest rates.
2. At higher nominal rates of interest, the demand for real balances is:
A) higher because savers can earn higher returns.
B) lower because the opportunity cost of holding those funds is higher.
C) invariant with respect to the nominal interest rate.
D) inversely related to the price level.
3. Assume sticky prices and given expectations of future exchange rates, what is the
immediate effect on the exchange rate of the U.S. dollar (purchasing euros) if there is a
temporary increase in the quantity of U.S. dollars?
A) U.S. nominal and real returns rates decline while euro rates hold steady, and
the U.S. dollar depreciates against the euro.
B) U.S. nominal returns rise, U.S. real returns fall, euro rates rise, and the U.S. dollar
appreciates against the euro.
C) U.S. nominal returns fall, U.S. real returns rise, euro rates fall, and the U.S. dollar
appreciates against the euro.
D) U.S. dollar returns and euro returns both rise, leaving the exchange rate unchanged.
4. When there is a permanent fall in the domestic money supply, the exchange rate:
A) falls in the short run and rises slightly in the long run.
B) falls in the short run and falls more in the long run.
C) rises in the short run and falls slightly in the long run.
D) rises in the short run and rises more in the long run.
5. If there is a permanent increase of 8% in the domestic money supply, then which of the
following will be true in the long run?
A) Prices will decrease by 8%.
B) Prices will increase by 4%.
C) The home country currency will depreciate by 8%.
D) The home country currency will appreciate by 4%.
6. With fixed exchange rates and capital mobility:
A) interest rates in the home country and in foreign countries are equalized.
B) interest rates in the home country are higher.
C) interest rates in foreign countries are higher.
D) monetary policy maintains its autonomy.
7. If an economy wants to maintain monetary policy autonomy, then:
A) it can maintain a fixed exchange rate and international capital mobility.
B) it can impose strict capital controls and maintain a fixed exchange rate.
C) it can maintain capital mobility but not a fixed exchange rate.
D) it can impose strict capital controls and maintain a fixed exchange rate or it
can maintain capital mobility but not a fixed exchange rate.
Use the following to answer next two questions:
Table: Hypothetical Canadian National Income and Product Accounts Data
Category
Consumption (personal consumption expenditures)
Investment (gross private domestic investment)
Government consumption (government expenditures)
Exports
Imports
Foreign income payments to domestic factors
Domestic income payments to foreign factors
Net unilateral transfers
Billions of dollars
400
150
80
210
60
20
10
5
8. (Table: Hypothetical Canadian National Income and Product Accounts Data) The GNE is
_______.
A) $630
B) $550
C) $230
D) $120
9. (Table: Hypothetical Canadian National Income and Product Accounts Data) The trade balance
for the economy provided is ______.
A) –$60
B) –$150
C) $150
D) $270
Use the following to answer next question:
Table: Hypothetical Irish National Income and Product Accounts Data
Category
Consumption (personal consumption expenditures)
Investment (gross private domestic investment)
Government consumption (government expenditures)
Exports
Imports
Foreign income payments to domestic factors
Domestic income payments to foreign factors
Net unilateral transfers
Billions of dollars
1,200
700
200
500
600
100
400
–10
10. (Table: Hypothetical Irish National Income and Product Accounts Data) What is the current
account for Ireland?
A) $310
B) $290
C) –$290
D) –$410
11. If investment exceeds national savings, then the current account:
A) must be negative.
B) must be zero.
C) must be positive.
D) not enough information
12. If George purchases shoes from a Japanese firm for $100, and pays for them by borrowing $100
on his Japanese credit card, the two accounts that are affected are:
A) imports of goods with a minus (debit) and exports of goods with a plus (credit).
B) imports of goods with a minus (debit) and exports of financial assets with a plus
(credit).
C) exports of goods with a minus (debit) and imports of financial assets with a plus (credit).
D) exports of goods with a plus (credit) and imports of financial assets with a minus (debit).
13. A key assumption to ensure that domestic returns and foreign returns are in equilibrium
is:
A) there are perfectly flexible prices.
B) the quantity of money is fixed.
C) there are no capital controls preventing the movement of capital.
D) trade is not subject to any restrictions.
14. Nominal interest rates are considered to be _____ in the short-run model.
A) flexible
B) rigid
C) zero
D) set by the central bank
15. In the short run, when the central bank increases the quantity of money, what happens to
real balances?
A) They do not change since prices will rise by the same proportion.
B) They will fall since prices will rise by a greater proportion.
C) They will rise since prices overall will fall.
D) They will rise since prices will not change in the short run.
16. Asset exports occur when domestic entities:
A) save internationally by purchasing foreign assets.
B) borrow internationally by selling assets to foreigners.
C) increase savings and decrease spending both domestically and internationally.
D) decrease savings and increase spending on foreign goods.
17. If we add the current account balances for every nation, the overall balance will equal:
A) the size of world GDP.
B) spending minus savings.
C) zero.
D) the value added in the manufacturing sectors of each nation.
18. Assuming all transactions are recorded, if the United States has an overall deficit (–) in
its current account, what is the implication for the balances of the other accounts (capital
and financial)?
A) Added (FA + KA), they must be in surplus (+) by exactly the same amount.
B) Their difference (FA – KA) is equal to the deficit (–) in the current account.
C) Added (FA + KA), they will be in deficit by exactly the same amount.
D) Their difference (FA – KA) must be equal to zero.
19. The article “Britain’s current account ” informs that
A) In past five years, UK’s foreign asset holdings have witnessed substantial capital
gains.
B) In recent years, UK’s income from foreign assets has been declining putting a
downward pressure on current account
C) UK has intervened to depreciate its currency for further encouraging exports
D) UK has been persistently running current account surpluses.
20. Assume that European money supply and all other variables remain constant. Now,
suppose a permanent increase in US money supply by 2% leads to a price rise of 2% in a
year’s time. By how much the expected dollar/euro exchange rate is expected to
appreciate/depreciate from its previous level if PPP is to hold? Now suppose in the short
run, because of the monetary expansion and price rigidity, the annual interest rate falls
from 5% to 4%. The annual euro interest rates are still at 5%. If UIP holds, by what % the
dollar/euro exchange rate should appreciate/depreciate over one year? If both your above
answers have to be correct, by what % must the spot exchange rate fall from its previous
level? (8 points)
If PPP is to hold the future dollar/euro exchange rate is to (rise) depreciate by 2% from its previous level.
When the dollar interest rate falls by 1% while the euro interest rate remains the same the dollar should
appreciate by 1% if UIP is to hold. The only way for the two to happen together is that the spot
dollar/euro rate rises by 3%. That is, dollar depreciates by 3% on impact of the policy change (right when
the money supply is increased) and then appreciates over time by 1%.
21. On the outlined graphs below, what are the markets that are represented? If the money supply
in the United States is temporarily increased from M1 to M2, and prices are sticky, trace the
effects of the change and predict the effect on the dollar, assuming other variables remain
constant. Explain why the observed change in the interest rate brings the observed change in the
exchange rate.(6 POINTS)
Answer: Money and Forex markets. The supply of real money curve will shift to the right, as
sticky prices create higher real balances. The demand for real money balances is unchanged, and
since the change is short run and temporary, expectations of future exchange rates do not change.
The equilibrium U.S. nominal interest rate is decreased, which shifts down the domestic return
line. Since foreign interest rates are unaffected, there is a new equilibrium of the DR and FR
lines at a higher exchange rate for foreign currency. Therefore, the U.S. dollar depreciates
22. In each of the following cases what specific entries will occur in the balance of payments
accounts? (4 points)
a. A US citizen buys Japanese bonds worth $10000 by paying through her checking
account.
FA- Import of assets: -$10000
FA- Export of deposits: $10000
b. You decide to send $500 worth of food items to Sudan as donation.
CA: Export of goods $500
CA: Unilateral transfers (out) -$500
23. An open economy’s output is expected to be 100 units forever and it can borrow and lend
freely from the rest of the world at an interest rate 10%... There is an unanticipated decrease in
output in the first period. That is, the economy’s output is 034, 100, 100, 100, 100….. On t =0, 1,
2, 3, 4…..Assume initial wealth is zero and there are no unilateral transfers. Assuming that the
economy always chooses a smooth consumption such that its present value equals that of the
output, what will be the consumption in the first period and thereafter? What will be the trade
balance? If the initial wealth is 0, what will be the wealth level at the end of period 0? What is
the trade balance, NFIA, Current account, and wealth level at the end of period 1? (10 points)
11 C = 1034
C = 94
TB0 = -60
NFIA0 = 0
CA0 = -60
W0 = -60
TB1 = 6
NFIA1 = -6
CA1 = 0
W1 = -60
24. Based on recent decline in Brazil’s currency: (4 points) What did the Brazil’s central bank
do to halt the depreciation of currency? Assuming real to be the domestic currency and dollar as
foreign currency, use the Forex market diagram to explain how this measure helps. (Bonus
question: 4 points)
The central bank raised benchmark interest rates. A rise in domestic interest rate will raise the DR line in
Forex market diagram, thereby appreciating the domestic nominal exchange rate. See Figure 4-3(a) in
the textbook. This is what the central bank is trying in order to stop the nominal exchange rate from
further depreciating.