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j2-11偶数题答案汇总

发布时间:2014-03-27 17:28:48  

Chapter 1 International Economics is Different

No Questions and Answers

Chapter 2 Payments among Nations

Suggested answers to questions and problems

(in the textbook)

2. Disagree, at least as a general statement. One meaning of a current account

surplus is that the country is exporting more goods and services than it is importing. One might easily judge that this is not good—the country is producing goods and services that are exported, but the country is not at the same time getting the imports of goods and services that would allow it do more consumption and domestic investment. In this way a current account deficit might be considered good—the extra imports allow the country to

consume and invest domestically more than the value of its current production. Another meaning of a current account surplus is that the country is engaging in foreign financial investment—it is building up its claims on foreigners, and this adds to national wealth. This sounds good, but as noted above it comes at the cost of foregoing current domestic purchases of goods and services. A current account deficit is the country running down its claims on foreigners or increasing its indebtedness to foreigners. This sounds bad, but it comes with the benefit of higher levels of current domestic expenditure. Different

countries at different times may weigh the balance of these costs and benefits differently, so that we cannot simply say that a current account surplus is better than a current account deficit.

4. Disagree. If the country has a surplus (a positive value) for its official

settlements balance, then the value for its official reserves balance must be a negative value of the same amount (so that the two add to zero). A negative value for this asset item means that funds are flowing out in order for the country to acquire more of these kinds of assets. Thus, the country is

increasing its holdings of official reserve assets.

6. a. CA = If, so if net foreign investment increases, then the value of the current

account increases.

b. If both exports (a positive item) and imports (a negative item) increase by

$10 billion, the value of the current account balance stays the same.

c. CA = Y ? E, so the combination of an increase in production (Y) by $100

billion and an increase in expenditures (E) by $150 billion results in a decrease in the value of the current account balance.

d. The transport equipment is an export of goods, so it is a positive item in

current account. It must be paired with a negative item of the same amount showing the unilateral transfer (gift). Because both of these items are

included in the current account, the value of the current account balance stays the same.

8. a. Goods and services balance: $330 ? 198 + 196 ? 204 = $124

Current account balance: $330 ? 198 + 196 ? 204 + 3 ? 8 = $119

Official settlements balance: $330 ? 198 + 196 ? 204 + 3 ? 8 + 102 ? 202 + 4 = $23

b. Change in official reserve assets (net) = ?official settlements balance =

?$23.

The country is increasing its net holdings of official reserve assets.

10. a. International investment position (billions): $30 + 20 + 15 ? 40 ? 25 = $0. The country is neither an international creditor nor a debtor. Its holding of

international assets equals its liabilities to foreigners.

b. A current account surplus permits the country to add to its net claims on

foreigners. For this reason the country's international investment position will become a positive value. The flow increase in net foreign assets results in the stock of net foreign assets becoming positive.

Chapter 3 The Foreign Exchange Market

Suggested answers to questions and problems

(in the textbook)

2. Exports of merchandise and services result in supply of foreign currency in the

foreign exchange market. Domestic sellers often want to be paid using

domestic currency, while the foreign buyers want to pay in their currency. In the process of paying for these exports, foreign currency is exchanged for

domestic currency, creating supply of foreign currency. International capital inflows result in supply of foreign currency in the foreign exchange market. In making investments in domestic financial assets, foreign investors often start with foreign currency and must exchange it for domestic currency before they can buy the domestic assets. The exchange creates supply of foreign currency. Sales of foreign financial assets that the country's residents had previously acquired, and borrowing from foreigners by this country's residents are other forms of capital inflow that can create supply of foreign currency.

4.

6. The U.S. firm obtains a quotation from its bank on the spot exchange rate for buying yen with dollars. If the rate is acceptable, the firm instructs its bank that it wants to use dollars from its dollar checking account to buy 1 million yen at this spot exchange rate. It also instructs its bank to send the yen to the bank account of the Japanese firm. To carry out this instruction, the U.S. bank instructs its correspondent bank in Japan to take 1 million yen from its account at the correspondent bank and transfer the yen to the bank account of the Japanese firm. (The U.S. bank could also use yen at its own branch if it has a branch in Japan.) The trader would seek out the best quoted spot rate for buying euros with

dollars, either by using the services of a foreign exchange broker or through direct contact with traders at other banks. The trader would use the best rate to buy euro spot. Sometime in the next hour or so (or, typically, at least by the end of the day), the trader will enter the interbank market again, to obtain the best quoted spot rate for selling euros for dollars. The trader will use the best spot rate to sell her previously acquired euros. If the spot value of the euro has risen during this short time, the trader makes a profit.

8. a. The cross rate between the yen and the krone is too high (the yen value of the

krone is too high) relative to the dollar-foreign currency exchange rates. Thus, in a profitable triangular arbitrage, you want to sell kroner at the high cross rate. The arbitrage will be: Use dollars to buy kroner at $0.20/krone, use these kroner to buy yen at 25 yen/krone, and use the yen to buy dollars at $0.01/yen. For each dollar that you sell initially, you can obtain 5 kroner, these 5 kroner can obtain 125 yen, and the 125 yen can obtain $1.25. The arbitrage profit for each dollar is therefore 25 cents.

b. Selling kroner to buy yen puts downward pressure on the cross rate (the

yen price of krone). The value of the cross rate must fall to 20 (=0.20/0.01) yen/krone to eliminate the opportunity for triangular arbitrage, assuming that the dollar exchange rates are unchanged.

10. a. The increase in supply of Swiss francs puts downward pressure on the

exchange-rate value ($/SFr) of the franc. The monetary authorities must

intervene to defend the fixed exchange rate by buying SFr and selling dollars.

b. The increase in supply of francs puts downward pressure on the

exchange-rate value ($/SFr) of the franc. The monetary authorities must

intervene to defend the fixed exchange rate by buying SFr and selling dollars.

c. The increase in supply of francs puts downward pressure on the

exchange-rate value ($/SFr) of the franc. The monetary authorities must

intervene to defend the fixed exchange rate by buying SFr and selling dollars.

d. The decrease in demand for francs puts downward pressure on the

exchange-rate value ($/SFr) of the franc. The monetary authorities must

intervene to defend the fixed exchange rate by buying SFr and selling dollars. Chapter 4 Forward Exchange and International Financial Investment

Suggested answers to questions and problems

(in the textbook)

2. You will need data on four market rates: The current interest rate (or yield) on

bonds issued by the U.S. government that mature in one year, the current

interest rate (or yield) on bonds issued by the British government that mature in one year, the current spot exchange rate between the dollar and pound, and the current one-year forward exchange rate between the dollar and pound. Do these rates result in a covered interest differential that is very close to zero?

4. a. The U.S. firm has an asset position in yen—it has a long position in yen. To

hedge its exposure to exchange rate risk, the firm should enter into a forward exchange contract now in which the firm commits to sell yen and receive

dollars at the current forward rate. The contract amounts are to sell 1 million yen and receive $9,000, both in 60 days.

b. The student has an asset position in yen—a long position in yen. To hedge

the exposure to exchange rate risk, the student should enter into a forward exchange contract now in which the student commits to sell yen and receive dollars at the current forward rate. The contract amounts are to sell 10 million yen and receive $90,000, both in 60 days.

c. The U.S. firm has an liability position in yen—a short position in yen. To

hedge its exposure to exchange rate risk, the firm should enter into a forward exchange contract now in which the firm commits to sell dollars and receive yen at the current forward rate. The contract amounts are to sell $900,000 and receive 100 million yen, both in 60 days.

6. Relative to your expected spot value of the euro in 90 days ($1.22/euro), the

current forward rate of the euro ($1.18/euro) is low—the forward value of the euro is relatively low. Using the principle of "buy low, sell high," you can speculate by entering into a forward contract now to buy euros at $1.18/euro. If you are correct in your expectation, then in 90 days you will be able to immediately resell those euros for $1.22/euro, pocketing a profit of $0.04 for each euro that you bought forward. If many people speculate in this way, then massive purchases now of euros forward (increasing the demand for euros forward) will tend to drive up the forward value of the euro, toward a current forward rate of $1.22/euro.

8. a. The Swiss franc is at a forward premium. Its current forward value

($1.010/SFr) is greater than its current spot value ($1.000/SFr).

b. The covered interest differential "in favor of Switzerland" is ((1 +

0.005)?(1.010) / 1.000) - (1 + 0.01) = 0.005. (Note that the interest rate used must match the time period of the investment.) There is a covered interest differential of about 0.5% for 30 days (about 6 percent at an annual rate). The U.S. investor can make a higher return, covered against exchange rate risk, by investing in SFr-denominated bonds, so presumably the investor should make this covered investment. Although the interest rate on SFr-denominated bonds is lower than the interest rate on dollar-denominated bonds, the forward premium on the franc is larger than this difference, so that the covered

investment is a good idea.

c. The lack of demand for dollar-denominated bonds (or the supply of these

bonds as investors sell them in order to shift into SFr-denominated bonds) puts downward pressure on the prices of U.S. bonds—upward pressure on U.S. interest rates. The extra demand for the franc in the spot exchange market (as investors buy SFr in order to buy SFr-denominated bonds) puts upward pressure on the spot exchange rate. The extra demand for SFr-denominated bonds puts upward pressure on the prices of Swiss bonds—downward pressure on Swiss interest rates. The extra supply of francs in the forward market (as U.S. investors cover their SFr investments back into dollars) puts downward pressure on the forward exchange rate. If the only rate that changes is the forward exchange rate, this rate must fall to about $1.005/SFr. With this

forward rate and the other initial rates, the covered interest differential is close to zero.

10. In testing covered interest parity, all of the interest rates and exchange rates

that are needed to calculate the covered interest differential are rates that can observed in the bond and foreign exchange markets. Determining whether the covered interest differential is about zero (covered interest parity) is then straightforward (although some more subtle issues regarding timing of

transactions may also need to be addressed). In order to test uncovered interest parity, we need to know not only three rates—two interest rates and the

current spot exchange rate—that can be observed in the market, but also one rate—the expected future spot exchange rate—that is not observed in any

market. The tester then needs a way to find out about investors' expectations. One way is to ask them, using a survey, but they may not say exactly what they really think. Another way is to examine the actual uncovered interest

differential after we know what the future spot exchange rate actually turns out to be, and see whether the statistical characteristics of the actual uncovered differential are consistent with an expected uncovered differential of about zero (uncovered interest parity).

Chapter 5 What Determines Exchange Rates?

Suggested answers to questions and problems

(in the text)

2. a. The euro is expected to appreciate at an annual rate of approximately ((1.005 ?

1.000)/1.000)?(360/180)?100 = 1%. The expected uncovered interest

differential is approximately 3% + 1% ? 4% = 0, so uncovered interest parity holds (approximately).

b. If the interest rate on 180-day dollar-denominated bonds declines to 3%, then

the spot exchange rate is likely to increase—the euro will appreciate, the

dollar depreciate. At the initial current spot exchange rate, the initial expected future spot exchange rate, and the initial euro interest rate, the expected

uncovered interest differential shifts in favor of investing in euro-denominated bonds (the expected uncovered differential is now positive, 3% + 1% ? 3% = 1%, favoring uncovered investment in euro-denominated bonds. The increased demand for euros in the spot exchange market tends to appreciate the euro. If the euro interest rate and the expected future spot exchange rate remain

unchanged, then the current spot rate must change immediately to be

$1.005/euro, to reestablish uncovered interest parity. When the current spot rate jumps to this value, the euro's exchange rate value is not expected to

change in value subsequently during the next 180 days. The dollar has

depreciated immediately, and the uncovered differential then again is zero (3% + 0% ? 3% = 0).

4. a. For uncovered interest parity to hold, investors must expect that the rate of

change in the spot exchange-rate value of the yen equals the interest rate differential, which is zero. Investors must expect that the future spot value is the same as the current spot value, $0.01/yen.

b. If investors expect that the exchange rate will be $0.0095/yen, then they

expect the yen to depreciate from its initial spot value during the next 90 days. Given the other rates, investors tend to shift their investments toward

dollar-denominated investments. The extra supply of yen (and demand for dollars) in the spot exchange market results in a decrease in the current spot value of the yen (the dollar appreciates). The shift to expecting that the yen will depreciate (the dollar appreciate) sometime during the next 90 days tends to cause the yen to depreciate (the dollar to appreciate) immediately in the current spot market.

6. The law of one price will hold better for gold. Gold can be traded easily so

that any price differences would lead to arbitrage that would tend to push gold prices (stated in a common currency by converting prices using market

exchange rates) back close to equality. Big Macs cannot be arbitraged. If price differences exist, there is no arbitrage pressure, so the price differences can persist. The prices of Big Macs (stated in a common currency) vary widely around the world.

8. According to PPP, the exchange rate value of the DM (relative to the dollar)

increased since the early 1970s because Germany experienced less inflation than did the United States—the product price level rose less in Germany since the early 1970s than it rose in the United States. According to the monetary approach, the German price level did not rise as much because the German money supply increased less than the money supply increased in the United States, relative to the growth rates of real domestic production in the two countries. The British pound is the opposite case—more inflation in Britain than in the United States, and higher money growth in Britain.

10. a. Because the annual growth rate of the domestic money supply (Ms) is two

percentage points higher than it was previously, the monetary approach

indicates that the exchange rate value (e) of the foreign currency will be higher than it otherwise would be—that is, the exchange rate value of the country's currency will be lower. Specifically, the foreign currency will appreciate by two percentage points more per year, or depreciate by two percentage points less. That is, the domestic currency will depreciate by two percentage points more per year, or appreciate by two percentage points less.

b. The faster growth of the country's money supply eventually leads to a faster

rate of inflation of the domestic price level (P). Specifically, the annual

inflation rate will be two percentage points higher than it otherwise would be. According to relative PPP, a faster rate of increase in the domestic price level (P) leads to a higher rate of appreciation of the foreign currency.

12. a. For the United States in 1975, 20,000 = k?100?800, or k = 0.25.

For Pugelovia in 1975, 10,000 = k?100?200, or k = 0.5.

b. For the United States, the quantity theory of money with a constant k

means that the quantity equation with k = 0.25 should hold in 2008: 65,000 = 0.25?260?1,000. It does. Because the quantity equation holds for both years with the same k, the change in the price level from 1975 to 2008 is consistent with the quantity theory of money with a constant k. Similarly, for Pugelovia, the quantity equation with k = 0.5 should hold for 2008, and it does (58,500 = 0.5?390?300).

14. a. The tightening typically leads to an immediate increase in the country's

interest rates. In addition, the tightening probably also results in investors' expecting that the exchange-rate value of the country's currency is likely to be higher in the future. The higher expected exchange-rate value for the currency is based on the expectation that the country's price level will be lower in the future, and PPP indicates that the currency will then be stronger. For both of these reasons, international investors will shift toward investing in this

country's bonds. The increase in demand for the country's currency in the spot exchange market causes the current exchange-rate value of the currency to increase. The currency may appreciate a lot because the current exchange rate must "overshoot" its expected future spot value. Uncovered interest parity is reestablished with a higher interest rate and a subsequent expected

depreciation of the currency.

b. If everything else is rather steady, the exchange rate (the domestic currency

price of foreign currency) is likely to decrease quickly by a large amount. After this jump, the exchange rate may then increase gradually toward its long-run value—the value consistent with PPP in the long run.

Chapter 6 Government Policies toward the Foreign Exchange Market

Suggested answers to questions and problems

(in the textbook)

2. We often use the term pegged exchange rate to refer to a fixed exchange rate,

because fixed rates generally are not fixed forever. An adjustable peg is an exchange rate policy in which the "fixed" exchange rate value of a currency

can be changed from time to time, but usually it is changed rather seldom (for instance, not more than once every several years). A crawling peg is an

exchange rate policy in which the "fixed" exchange rate value of a currency is changed often (for instance, weekly or monthly), sometimes according to indicators such as the difference in inflation rates.

4. Disagree. If a country is expected to impose exchange controls, which usually

make it more difficult to move funds out of the country in the future, investors are likely to try to shift funds out of the country now before the controls are imposed. The increase in supply of domestic currency into the foreign

exchange market (or increase in demand for foreign currency) puts downward pressure on the exchange rate value of the country's currency—the currency tends to depreciate.

6. a. The market is attempting to depreciate the pnut (appreciate the dollar) toward

a value of 3.5 pnuts per dollar, which is outside of the top of the allowable band (3.06 pnuts per dollar). In order to defend the pegged exchange rate, the Pugelovian monetary authorities could use official intervention to buy pnuts (in exchange for dollars). Buying pnuts prevents the pnut’s value from

declining (selling dollars prevents the dollar’s value from rising). The

intervention satisfies the excess private demand for dollars at the current

pegged exchange rate.

b. In order to defend the pegged exchange rate, the Pugelovian government

could impose exchange controls in which some private individuals who want to sell pnuts and buy dollars are told that they cannot legally do this (or cannot do this without government permission, and not all requests are approved by the government). By artificially restricting the supply of pnuts (and the

demand for dollars), the Pugelovian government can force the remaining

private supply and demand to "clear" within the allowable band. The

exchange controls attempt to stifle the excess private demand for dollars at the current pegged exchange rate.

c. In order to defend the pegged exchange rate, the Pugelovian government

could increase domestic interest rates (perhaps by a lot). The higher domestic interest rates shift the incentives for international capital flows toward

investments in Pugelovian bonds. The increased flow of international financial capital into Pugelovia increases the demand for pnuts on the foreign exchange market. (Also, the decreased flow of international financial capital out of

Pugelovia reduces the supply of pnuts on the foreign exchange market.) By increasing the demand for pnuts (and decreasing the supply), the Pugelovian government can induce the private market to clear within the allowable band. The increased domestic interest rates attempt to shift the private supply and

demand curves so that there is no excess private demand for dollars at the

current pegged exchange rate value.

8. a. The gold standard was a fixed rate system. The government of each country

participating in the system agreed to buy or sell gold in exchange for its own currency at a fixed price of gold (in terms of its own currency). Because each currency was fixed to gold, the exchange rates between currencies also tended to be fixed, because individuals could arbitrage between gold and currencies if the currency exchange rates deviated from those implied by the fixed gold prices.

b. Britain was central to the system, because the British economy was the leader

in industrialization and world trade, and because Britain was considered

financially secure and prudent. Britain was able and willing to run payments deficits that permitted many other countries to run payments surpluses. The other countries used their surpluses to build up their holdings of gold reserves (and of international reserves in the form of sterling-denominated assets).

These other countries were satisfied with the rate of growth of their holdings of liquid reserve assets, and most countries were able to avoid the crisis of running low on international reserves.

c. During the height of the gold standard, from about 1870 to 1914, the

economic shocks to the system were mild. A major shock—World War

I—caused many countries to suspend the gold standard.

d. Speculation was generally stabilizing, both for the exchange rates between the

currencies of countries that were adhering to the gold standard, and for the exchange rates of countries that temporarily allowed their currencies to float.

10. a. The Bretton Woods system was an adjustable pegged exchange rate system.

Countries committed to set and defend fixed exchange rates, financing

temporary payments imbalances out of their official reserve holdings. If a

"fundamental disequilibrium" in a country's international payments developed, the country could change the value of its fixed exchange rate to a new value.

b. The United States was central to the system. As the Bretton Woods system

evolved, it became essentially a gold-exchange standard. The monetary

authorities of other countries committed to peg the exchange rate values of their currencies to the U.S. dollar. The U.S. monetary authority committed to buy and sell gold in exchange for dollars with other countries' monetary

authorities at a fixed dollar price of gold.

c. To a large extent speculation was stabilizing, both for the fixed rates

followed by most countries, and for the exchange rate value of the Canadian dollar, which floated during 1950-62. However, the pegged exchange rate

values of currencies sometimes did come under speculative pressure.

International investors and speculators sometimes believed that they had a one-way speculative bet against currencies that were considered to be "in trouble.” If the country did manage to defend the pegged exchange rate value of its currency, the investors betting against the currency would lose little. They stood to gain a lot of profit if the currency was devalued. Furthermore, the large speculative flows against the currency required large interventions to defend the currency's pegged value, so that the government was more likely to run so low on official reserves that it was forced to devalue.

12. a. The dollar bloc and the euro bloc. A number of countries peg their currencies

to the U.S. dollar. A number of European countries use the euro, and, in

addition, a number of other countries peg their currencies to the euro.

b. Other major currencies that float independently include (as of 2010) the

Japanese yen, the British pound, the Canadian dollar, and the Swiss franc.

Chapter 7 International Lending and Financial Crises Suggested answers to questions and problems

(in the textbook)

2. Disagree. In a sense a national government cannot go bankrupt, because it can

print its own currency. But a national government can refuse to honor its

obligations, even if it might be able to pay. If the benefit from not paying

exceeds the cost of not paying, the government may rationally refuse to pay. And, a national government can run short of foreign currency to pay

obligations denominated in foreign currency, because it cannot print foreign money.

4. The debt crisis in 1982 was precipitated by (a) increased cost of servicing

debt, because of a rise in interest rates in the United States and other

developed countries as tighter monetary policies were used to fight inflation, (b) decreased export earnings in the debtor countries, because of decreased demand and lower commodity prices as the tighter monetary policies resulted in a world recession, and (c) an investor shift to curtailing new lending and trying to get old loans repaid quickly, once it became clear that (a) and (b) would lead to some defaults.

6. With free international lending Japan lends 1,800 (= 6,000 ? 4,200) to

America, at point T. If Japan and America each impose a 2 percent tax on international lending, the total tax is 4 percent. The gap WZ restores

equilibrium, and the amount lent internationally declines to 600 (= 6,000 ? 5,400). The interest rate in Japan (and the one received net of taxes by Japan’s international lenders) is 3 percent and the interest rate in America (and the one paid including taxes by America’s international borrowers) is 7 percent. (The difference is the 4 percent of taxes.) Japan’s government collects

international-lending tax revenues equal to area r, but this is effectively paid by Japanese lenders who see their earnings on the 600 of foreign lending that continues decline by this amount. The net effect on Japan is a loss of area n because the taxes prevent some previously profitable lending from occurring. America’s government collects tax revenues equal to area k, but this is

effectively paid by American borrowers who must pay a higher interest rate on their foreign borrowing. The net effect on America is a loss of area j because of the decline in international borrowing.

8. a. The increase in the interest rate rotates the line showing the debt service due,

which is also the benefit from not repaying, upward to (1 + i?)D from (1 + i)D. The threshold amount of debt beyond which the country’s government should default declines to Dlim? from Dlim. This change can lead to default, even if the country’s government would not default before the change, if the actual

amount of debt is between Dlim? and Dlim

.

b. The increase in the cost of defaulting causes an upward shift to C? from C in

the curve showing the costs of not repaying. In this case the threshold

increases to Dlim? from Dlim. This change cannot lead to default if the country would not default before the change.

10. If a default has no other effect on Puglia, its government should default when

the incremental cost of servicing the debt (interest payment plus repayment of principal) becomes larger than the incremental inflow of funds from new loans. This occurs at the end of year 3, so the Puglian government should default at that time.

c. The exchange rates between the U.S. dollar and the other major currencies

have been floating since the early 1970s. The movements in these rates exhibit trends in the long run—over the entire period since the early 1970s. The rates also show substantial variability or volatility in the short and medium

runs—periods of less than one year to periods of several years. The long run trends appear to be reasonably consistent with the economic fundamentals emphasized by purchasing power parity—differences in national inflation rates. The variability or volatility in the short or medium run is controversial. It may simply represent rational responses to the continuing flow of economic and political news that has implications for exchange rate values. The effects on rates can be large and rapid, because overshooting occurs as rates respond to important news. However, some part of the large volatility may also reflect speculative bandwagons that lead to bubbles that subsequently burst and are reversed.

Chapter 8 How Does the Open Macroeconomy Work? Suggested answers to questions and problems

(in the textbook)

2. Disagree. The recession in the United States reduces U.S. national income, so

U.S. residents reduce spending on all kinds of things, including spending on imports. The decrease in U.S. imports is a decrease in the exports of other countries, including Europe’s exports to the United States. The reduction in European exports reduces production in Europe, so the growth of real GDP in Europe declines. A recession in the United States is likely to lower the growth of European real GDP.

4. a. The spending multiplier in this small open economy is about 1.82 (= 1/(0.15 +

0.4)). If real spending initially declines by $2 billion, then domestic product and income will decline by about $3.64 billion (= 1.82 ? $2 billion)

b. If domestic product and income decline by $3.64 billion, then the country's

imports will decline by about $1.46 billion (= $3.64 billion ? 0.4).

c. The decrease in this country's imports reduces other countries' exports, so

foreign product and income decline.

d. The decline in foreign product and income reduce foreign imports, so the

first country's exports decrease. This reinforces the change (decline) in the first country's domestic product and income—an example of foreign-income repercussions.

6. External balance is the achievement of a reasonable and sustainable makeup of

a country's overall balance of payments with the rest of the world. While

specifying a precise goal is not simple, we often presume that achieving a

balance of approximately zero in a country's official settlements balance is external balance. The FE curve shows all combinations of interest rate and domestic product that result in a zero balance for the country's official

settlements balance. Thus, any point on the FE curve is consistent with this concept of external balance.

8. a. A decrease in government spending tends to decrease domestic product (and

decrease interest rates because the government has to borrow less when it has a smaller budget deficit). Thus, the IS curve shifts to the left (or down).

b. An increase in foreign demand for the country's exports increases the

country's domestic product. Thus, the IS curve shifts to the right (or up).

c. An increase in the interest rate does not shift the IS curve. Rather, it results in

a movement along the IS curve.

10. a. Imports increase, according to the marginal propensity to import.

b. Our exports decrease, as foreign imports decrease according to the

foreign marginal propensity to import.

c. This makes our products relatively more expensive, and foreign products

relatively less expensive. The relative price of foreign products (or the real exchange rate value of foreign currency) Pf ?e/P decreases if P increases. The reduction in the price competitiveness of our products internationally tends to decrease our exports and increase our imports.

d. This makes our products relatively less expensive. The relative price of

foreign products (or real exchange rate value of foreign currency) Pf ?e/P

increases if Pf increases more than P. The increase in the price competitiveness of our products internationally tends to increase our exports and decrease our imports.

Chapter 9 Internal and External Balance with Fixed Exchange Rates

Suggested answers to questions and problems

(in the textbook)

2. The increase in government spending affects both the current account and the

financial account of the country's balance of payments. The increase in

government spending increases aggregate demand, production, and income. The increase in income and spending increases the country's imports, so the current account tends to deteriorate (to become a smaller positive value or a larger negative value). The increase in production, income, and spending increases the demand for money. If the country's central bank does not permit the money supply to expand, then interest rates increase. (Similarly, the

increase in the government budget deficit requires the government to borrow more to finance its deficit, increasing interest rates.) The increase in interest rates increases the inflows of financial capital into the country (and decreases outflows), so that the financial account improves.

We are not sure about the effect of the policy change on the country's official settlements balance. It depends on the sizes of the changes in the two

accounts. If the financial account improvement is larger (as we often expect in the short run), then the official settlements balance goes into surplus. If the current account deterioration is larger (as we often expect in the long run), then the official settlements balance goes into deficit.

If the official settlements balance goes into surplus, then the central bank must defend the fixed exchange rate through intervention by buying foreign

currency and selling domestic currency. As the central bank sells domestic currency, this expands the domestic money supply if the intervention is

unsterilized. This reinforces the expansionary thrust of the increase in

government spending.

If the official settlements balance goes into deficit, then the central bank must defend the fixed exchange rate through intervention by selling foreign

currency and buying domestic currency. As the central bank buys domestic currency, this contracts the domestic money supply if the intervention is

unsterilized. This tends to reduce the expansionary thrust of the increase in government spending.

The assignment rule says that a country with a fixed exchange rate can pursue both external balance and internal balance by assigning fiscal policy the task of achieving internal balance and assigning monetary policy the task of

achieving external balance. The possible advantages of the assignment rule include: (1) it provides clear guidance to both types of policy, so that they can address macroeconomic stabilization even in cases in which apparent policy dilemmas exist, and (2) it directs each type of policy to focus on the target that each tends to care more about. The possible disadvantages of the assignment rule include: (1) it depends on the effect of interest rates on international

capital flows, so that it will not work if capital flows are not that responsive to interest rate changes, or it may not work beyond the short-run period, because 4.

in the long run capital flows stop responding or tend to reverse, (2) lags in policy responses could destabilize the economy rather than stabilize it, (3) it may not be politically possible in some countries to run monetary policy

separately from fiscal policy, (4) it may not be politically possible in some countries to run fiscal policy to address economic objectives such as internal balance, and (5) the policy mix can result in high domestic interest rates that can reduce domestic real investment and slow the growth of the country's supply capabilities in the long run.

6. a. Pugelovian holdings of official international reserves decrease by $10 billion,

a decline in holdings of foreign-exchange assets (assuming that the Pugelovian central bank did not just borrow the dollars used in the intervention).

b. The Pugelovian central bank is also buying pnuts in the intervention, so the

Pugelovian money supply declines. Because this is removing high-powered money from the Pugelovian banking system, the Pugelovian money supply decreases by more than the size of the intervention, with the actual decrease depending on the size of the money multiplier.

c. The Pugelovian money supply does not change (or does not decrease as

much) if the Pugelovian central bank sterilizes. To sterilize the intervention, the Pugelovian central bank would buy Pugelovian government bonds. As the central bank pays for the bonds, it is adding high-powered Pugelovian money back into the banking system. If it adds back the amount that was removed by the intervention, then the overall amount of high-powered money in the

economy is unchanged, and the regular money supply can also be unchanged.

8. a. If the country's financial account is always zero, then the country's interest

rates have no direct effect on the country's balance of payments. The FE curve is a vertical line. (The country's overall payments balance is the same as its current account balance. The current account balance is affected by the

country's domestic product and income through the demand for imports, but it

is essentially not affected directly by the country's interest rates.)

b. The increase in foreign demand for the country’s exports shifts the IS curve

to the right to IS' in the accompanying graph. The shock increases demand for the country's products, so domestic product and income tend to rise. The

increase in foreign demand for the country’s exports shifts the FE curve to the right also, to FE'. At the initial level of income and domestic product, the

current account and the overall payments balance go into surplus. A zero

balance can be reestablished on the new FE' curve by increasing imports

through an increase in domestic product and income. The LM curve is not directly affected, if this shock does not directly change money supply or

money demand.

c. The rightward shift of the IS curve results in a new IS'-LM intersection with

some increase in the level of domestic product. The increase in domestic

product and income also increases the country's imports. To proceed, let's examine the "normal" case in which the country then has a current account and overall payments surplus, because the increase in exports is larger than the initial increase in imports. This means that the intersection of the original LM curve and the new IS' curve at E' is to the left of the new FE' curve. If the

country's official settlements balance goes into surplus, then the country's

central bank must intervene to defend the fixed exchange rate by buying

foreign currency and selling domestic currency.

d. Assuming that the intervention is not sterilized, the intervention increases the

country's money supply. The LM curve shifts to the right (or down). The

country returns to external balance at the triple intersection E" when the LM curve has shifted to LM'. The country's domestic product and income have increased, from Y0 to Y1. If the country initially began with a high

unemployment rate, then this is a movement toward internal balance. If the

country initially began with internal balance or with an inflation rate that was

considered too high, then this is a move away from internal balance, because the extra foreign and domestic spending on the country's products tends to drive the inflation rate up as the stronger demand exceeds the economy's supply capabilities.

10. a. The value of the Pugelovian current account, measured in foreign currency

units, is:

CA = Pfcx ? X ? Pfcm ? M.

If there is no change in quantities demanded (X and M are unchanged), then

export and import markets must clear at the same supply prices. Pugelovian exporters receive the same competitive export price (measured in Pugelovian pnuts), so that the foreign-currency price of Pugelovian exports (Pfcx) falls when the Pugelovian currency is devalued. Also, the foreign suppliers of

Pugelovia's imports continue to charge the same foreign currency supply price (Pfcm is unchanged). Thus, the Pugelovian current account deficit becomes larger, because the foreign-currency value of Pugelovian exports declines, and the foreign-currency value of Pugelovian imports is unchanged. Because the import demand elasticities are low (actually, zero), the response of the current account balance to the devaluation is perverse (it deteriorates rather than

improves).

b. If Pugelovian firms keep their pnut prices of their exports the same, then the

devaluation results in a decrease in the foreign-currency price of Pugelovian exports (Pfcx). Generally, foreign buyers will buy a larger quantity of

Pugelovian exports (X increases). If foreign firms keep the foreign-currency prices of their exports (Pfcm) the same, then the devaluation results in a higher pnut price of imports in Pugelovia. Generally, Pugelovian buyers will buy a smaller quantity of imports (M falls). In this case, the Pugelovian current account could deteriorate, stay the same, or improve. Given the price changes (especially the decrease in the foreign-currency price of Pugelovian exports), the change in the value of the Pugelovian current account depends on the size of the responses in quantities demanded. If the responses are large enough (X rises and M falls enough), then the value of the Pugelovian current account deficit will decrease (its current account will improve). If the responses are small (X increases and M decreases only a little), then the value of the deficit will increase (the current account will deteriorate). The quantity changes are larger if the price elasticities of import demand in the two countries are larger (in absolute values).

Chapter 10 Floating Exchange Rates and Internal Balance Suggested answers to questions and problems

(in the textbook)

2. The increase in government spending affects both the current account and the

financial account of the country's balance of payments. The increase in

government spending increases aggregate demand, production, and income. The increase in income and spending increases the country's imports, so the current account tends to deteriorate (become a smaller positive value or a larger negative value). The increase in production, income, and spending also increases the demand for money. If the country's central bank does not permit the money supply to expand, then interest rates increase. (Similarly, the

increase in the government budget deficit requires the government to borrow more to finance its deficit, increasing interest rates.) The increase in interest rates increases the inflows of financial capital into the country (and decreases outflows), so that the financial account tends to improve.

The effect of this policy change on the exchange rate value of the country's currency depends on the effect on the official settlements balance. However, we are not sure about the effect of the policy change on the country's official settlements balance. It depends on the sizes of the changes in the two

accounts. If the financial account improvement is larger (as we often expect in the short run), then the official settlements balance tends to go into surplus. If the current account deterioration is larger (as we often expect in the long run), then the official settlements balance tends to go into deficit.

If the official settlements balance tends to go into surplus, then the exchange rate value of the country's currency increases. The country loses international price competitiveness, and net exports tend to decrease. This reduces the expansionary thrust of the increase in government spending.

If the official settlements balance tends to go into deficit, then the exchange rate value of the country's currency decreases. The country gains international price competitiveness, and net exports tend to increase. This reinforces the expansionary thrust of the increase in government spending.

The decrease in demand for money tends to reduce domestic interest rates. The lower domestic interest rates encourage borrowing and spending, so

domestic product and income increase because of the increase in domestic expenditure. The country's current account tends to deteriorate because the increase in domestic product and income increases imports. In addition, the country's financial account tends to deteriorate, because the lower domestic interest rates encourage a capital outflow. As the country's official settlements balance tends to go into deficit, the exchange rate value of the country's

currency depreciates. The country gains international price competitiveness, and net exports tend to increase. This reinforces the expansion of domestic product and income. 4.

Under fixed exchange rates, the central bank instead must resist the downward

pressure on the exchange rate value of the country's currency by intervening in the foreign exchange market—the central bank must buy domestic currency and sell foreign currency. In buying domestic currency, the central bank

reduces the domestic money supply (assuming that it does not sterilize). The contraction of the domestic money supply tends to counter the initial

expansion of domestic product and income.

6. a. The contractionary monetary policy increases domestic interest rates, so

borrowing and spending decrease. Domestic product and income tend to

decline. The decline in demand puts downward pressure on the British

inflation rate.

b. The increase in British interest rates draws a capital inflow, so Britain's

financial account tends to improve. The decrease in British product and

income reduces imports, so Britain's current account tends to improve. Thus, Britain's overall payments tend to go into surplus, so the exchange rate value of the pound tends to increase (the pound tends to appreciate).

c. As the pound appreciates, Britain tends to lose international price

competitiveness (assuming overshooting—the currency appreciation occurs more quickly than the decline in the British inflation rate). British net exports tend to decline. This reinforces the contractionary thrust of British monetary policy on domestic product and income. In addition, it also reinforces the

downward pressure on the British inflation rate, both because demand declines further, and because the appreciation tends to reduce the British pound prices of imports into Britain.

8. The increase in the foreign money supplies tends to lower foreign interest

rates. The lower foreign interest rates spur borrowing and spending in foreign countries. The increase in foreign product and income increases the demand for imports, so our exports increase. In addition, the exchange rate values of foreign currencies decline, so that our currency appreciates. Foreign currencies depreciate because the overall foreign payments tend to go into deficit. The foreign current accounts tend to decline as foreign imports increase, and the foreign financial accounts tend to decline as the lower foreign interest rates spur capital outflows. The appreciation of our currency lowers our

international price competitiveness, so our net exports tend to decrease. This counters the more direct effect of changes in international trade on our

domestic product and income. This is an example of how floating exchange rates tend to reduce the domestic impact of an international shock, in this case a foreign monetary shock.

10. a. The increase in foreign demand for the country’s exports shifts the IS curve to

the right to IS' in the accompanying graph. The shock increases demand for the country's products, so domestic product and income tend to rise. The

increase in foreign demand for the country’s exports shifts the FE curve to the right also, to FE'. At the initial level of income and domestic product, the

current account and the overall payments balance go into surplus. A zero

balance can be reestablished on the new FE' curve by increasing imports

through an increase in domestic product and income. The LM curve is not directly affected, if this shock does not directly change money supply or

money demand.

b. The rightward shift of the IS curve results in a new IS'-LM intersection with

some increase in the level of domestic product. The increase in domestic

product and income also increases the country's imports. To proceed, let's examine the "normal" case in which the country then tends to have a current account and overall payments surplus, because the increase in exports is larger than the initial increase in imports. This means that the intersection of the original LM curve and the new IS' curve at E' is to the left of the new FE'

curve. If the country's official settlements balance tends to go into surplus, then the exchange rate value of country's currency appreciates.

c. The currency appreciation reduces the country's international price

competitiveness, and the country's net exports decrease. As the reduction in net exports reduces demand for the country's domestic product, the IS' curve shifts back toward the original IS curve. As the current account declines with the loss of price competitiveness, the FE' curve shifts back toward the original FE curve. If nothing else fundamental changes, then the curves shift back to their original positions, and the new triple intersection is back to the original

one at E. There may be little or no effect on internal balance of all of this taken

together (the international trade shock in favor of the country's exports plus the appreciation of the country's currency).

Chapter 11 National and Global Choices: Floating Rates and the Alternatives

Suggested answers to questions and problems

(in the textbook)

2. Probably agree, but with a caution. It is usually argued that the average rate of

global inflation would tend to be lower if most countries adhered to a system of fixed exchange rates. Countries that succeed in maintaining fixed exchange rates among their currencies must have similar inflation rates in the long run. This tends to discipline countries that otherwise would drift or surge toward higher inflation rates. Furthermore, there is more pressure on countries with payments deficits to adjust than there is on surplus countries. In defending the fixed exchange rates, countries with payments deficits must intervene to buy their own currency. This tends to contract their money supplies and reduce their inflation rates. Thus, overall, the world tends toward less money growth and a lower average rate of world inflation. There is one caution, however. If the system has a lead country, then the inflation rate that forms the standard for the system is this country's inflation rate. Some countries that otherwise would prefer to have an even lower inflation rate will find that their inflation rate is drifting up toward the rate in the lead country.

4. Agree or disagree. If you say agree, then you will emphasize points like the

following. With a clean floating exchange rate, the rate is set by private

competitive supply and demand in the market. This rate is a market price that represents all information about currency values that is available at that time. Governments have no special information, so that they cannot improve on the clean float. Intervention by the government in the exchange market often

seems to have little effect on exchange rate values. When it does have an

impact, it distorts the exchange rate, usually for political purposes, especially to respond to the desires of powerful special interests.

If you disagree, then you will emphasize points like the following. Cleanly

floating exchange rates are excessively variable, perhaps because private

supply and demand are sometimes driven not by rational examination of

information on the economic fundamentals, but rather by bandwagons and similar speculative behavior, or simply because exchange rates tend to

overshoot their long-run values. Thus, a managed float permits a country to

obtain many of the benefits of a floating exchange rate, including some policy independence and the ability to use exchange rate changes in the process of adjustment to external imbalances, while using intervention to limit wide

swings and excessive variability in exchange rate values.

6. a. These economists believe that the variability exists for good reasons, and that

many of the supposed bad effects of exchange rate variability are not that

large. They believe that the variability results from rational and reasonable responses of market participants, especially international investors, to various kinds of shocks and news. As economic and political conditions change,

exchange rates should change to reflect the new information about the relative values of currencies. They believe that variability does not lead to risk that unreasonably reduces international transactions. Those engaged in

international transactions like trade in goods and services have a variety of ways to hedge their exposures to exchange rate risk, including forward foreign exchange contracts as well as currency futures, options, and swaps.

b. These economists believe that the variability is excessive, and that the risks do

have an undesirable impact on international transactions. They believe that the variability sometimes results from bandwagons and similar expectations that carry exchange rates away from their appropriate economic values. In

addition, overshooting can cause exchange rates to deviate from their longer run values, even if the rates follow a path that is economically rational. They believe that some of the resulting exchange rate risk does have an impact on international transactions, because it is not possible to hedge perfectly and costlessly. Risk may especially affect real investments that support exports and similar international transactions, because the risk that must be hedged is further in the future, and because the payments at risk are themselves often of uncertain sizes. Furthermore, they believe that excessive rate movements that persist beyond the short run, such as the overshooting that can keep exchange rates away from their longer run values for a number of years, create signals for resource reallocations that are too large or too rapid.

8. The five convergence criteria are: (1) the country's inflation rate must be no

more than 1.5 percentage points above the average inflation rate of the three lowest inflation EU countries, (2) the country's exchange rates must have been maintained within the ERM band with no realignments during the previous two years, (3) the country's long-term interest rate on government bonds must be no more than 2 percentage points above the average of the rates in the three lowest inflation countries, (4) the country's government budget deficit must be less than or equal to 3 percent of the value of its GDP, and (5) the country's gross government debt must be less than or equal to 60 percent of the value of its GDP. For the latter two criteria the country need not meet them exactly, as

long as the country shows adequate progress toward achieving them in the near future.

We can guess about the logic for each requirement. The inflation criterion

shows that the country is ready to switch smoothly to fixed exchange rates with other low inflation countries. It is based on the logic of purchasing power parity—that countries must maintain similar inflation rates if fixed rates are to be sustained. The exchange rate criterion shows that the country already has been able to maintain a pegged exchange rate, so that it is ready to switch smoothly to completely fixed exchange rates. In addition, the criterion may be intended to limit a country's ability to use "one last" devaluation to gain a competitive edge in pricing just before it enters into "permanently" fixed exchange rates. The interest rate criterion may show that credit markets judge the country to be a good inflation rate risk and good credit risk. A country that is not expected to maintain a low inflation rate probably has to pay a higher interest rate on its long term debt. Its tendency toward higher inflation in the future would threaten the viability of the fixed exchange rates. Even worse, a country whose government might run into problems in repaying its debts also probably has to pay a higher interest rate on its long term government debt. If the government does then run into problems, the other countries may be forced to bail it out in order to defend the monetary union. The two criteria related to the government budget deficit and debt seem to be related to achieving fiscal policies that are not too different between the countries that enter into the fixed exchange rates. This may limit strains within the system. Especially, it keeps out countries who might favor more inflationary monetary policies to bail them out in the face of excessive government budget deficits and debt.

Given the importance of having and maintaining similar inflation rates for the success of fixed exchange rates, the most important criterion is probably that related to the country's inflation rate. The criteria related to government budget deficits and debt seem to be more debatable. A country that shifts to completely fixed exchange rates has given up the ability to use national

monetary policy and exchange rate changes in seeking to address imbalances. This country may need to use fiscal policy more actively, including sometimes running large budget deficits. If the criteria also restrain the independence of fiscal policy, the country's government is left with little in the way of policy tools to address national imbalance. However, the series of government debt crises that hit Greece, Ireland, and Portugal beginning in 2010 show that excessive fiscal deficits and government debts can create large problems for the monetary union.

Here are several arguments in favor of a Britain staying out of the European Monetary Union and instead maintaining its policy of an independently 10.

floating exchange rate for the pound. First, changes in the floating

exchange-rate value of the pound can be used in adjusting to reduce external imbalances that Britain might face. Changes in the exchange-rate value of the pound can also reduce the Britain’s vulnerability to external shocks, including shocks coming from other EU countries. Second, adoption of floating

exchange rates allows Britain to pursue its own monetary policy. Monetary policy can be used to seek internal balance, and Britain’s government has a greater ability to pursue its own goals and priorities. The ability to use

monetary policy to fight a British recession and high British unemployment can be especially valuable if fiscal policy is not flexible enough to be useful in pursuing internal balance, and if movements of labor between countries of the union are not likely to be large enough (or perhaps even not desirable) as a way to smooth cyclical differences between these countries. Third, those affected by the variability of floating exchange rates have a variety of means of hedging their exposures to exchange rate risks, including forward foreign exchange contracts and currency futures, options, and swaps. These contracts are available with very low transactions costs. Fourth, Britain’s inflation rate is best controlled by a British central bank that is committed to this goal. Although the European Central Bank is structured like the German central bank, it is also subject to political pressures that could reduce its commitment to maintaining low inflation, so there is no guarantee that Britain will have lower inflation if it joins the monetary union. Finally, staying out of the

European Monetary Union assures that Britain is not so directly exposed to the fiscal problems in some other euro-area countries (for example, Greece).

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