2. Suppose that there is a wave of pessimism in the economy due to Covid-19 and, as a result,the economy is operating below its natural level of output with high unemployment and lowinflation. So, the central bank decided to stimulate the economy. Assume a small openeconomy with perfect capital mobility and a flexible exchange rate system.a) (i) Should the central bank increase or decrease the money supply if it wants to stimulatethe economy? Explain.(ii) List two monetary policy tools that the central bank uses to influence the moneysupply and explain how each tool should be applied to be consistent with your responsein (i).b) Which macroeconomic variables change immediately and in what direction?c) Which macroeconomic variables change over the short run and in what direction?d) What happens to employment and inflation? Does the rate of economic growth increase?

a) (i) Should the central bank increase or decrease the money supply if it wants to stimulate the…

Answered: 2. Suppose that there is a wave of…

Principles of Economics 2e

2nd Edition

ISBN:9781947172364

Author:Steven A. Greenlaw; David Shapiro

Publisher:Steven A. Greenlaw; David Shapiro

Chapter29: Exchange Rates And International Capital Flows

Section: Chapter Questions

Problem 7SCQ: How would a contractionary monetary policy affect the exchange rate, net exports, aggregate demand,...

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A central bank can allow its currency to fall indefinitely, but it cannot allow its currency to rise indefinitely. Why not?
1. Suppose in the New Keynesian open-economy model that there is a negative output gap andthe central bank decreases the current money supply.(a) Assuming that the exchange rate is flexible. Draw diagrams for the labour, goods andmoney markets, and the production function. Determine the equilibrium effects of thisdecrease in the money supply on employment, output, consumption, investment, money,real wages, the real interest rate, the price level and the exchange rate. Provide a detailedeconomic analysis explaining your results with the aid of the diagrams.(b) Repeat part (a) for the case of a fixed exchange rate.
1, Given the discussion of the effects of monetary policy in this chapter, how does a foreign monetary expansion affect domestic output? A. A foreign monetary expansion has no effect on domestic output. B. A foreign monetary expansion has an ambiguous effect on domestic output. C. A foreign monetary expansion is likely to increase domestic output. D. A foreign monetary expansion is likely to decrease domestic output. 2. Considering the IS curve in a closed economy, an increase in interest rates causes decrease in: A. demand for domestic goods. B. investment. C. output. D. all of the above. 3. Considering the IS curve in an open economy, an increase in interest rates causes __ no effect a decrease an increase in net exports.
2. Based on the IS-LM-PC model for a closed economy studied in class, which of the following statements is correct? a) In the medium run monetary policy can only be used to control inflation, but it will not affect production. b) In the medium run, fiscal policy can only help to increase or decrease interest rates, but it will not affect production. c) Both monetary and fiscal policy can't be effectively uscd to increase production in the short run. d) All of the above.
3. Consider the following classical economy: Desired consumption Desired investment Government purchases Net exports Real exchange rate Full-employment output C=300+0.5Y-200r Id=200-300r G=100 NX-150-0.1Y-0.5e e=20+600r Y = 900 In this economy, the real interest rate does not devi- ate from the foreign interest rate. a. What are the equilibrium values of the real interest rate, the real exchange rate, consumption, invest- ment, and net exports? b. Now, suppose that full-employment output increases to 940. What are the equilibrium values of the real interest rate, the real exchange rate, consumption, investment, and net exports?
In August 2015 investor sentiment shifted against the Chinese yuan. Investors sold the yuan and bought dollars, as financial capital flowed out of China, seeking better rates of return in other countries. What actions did China take in response to this situation? O China used $1 trillion of its foreign exchange reserves to purchase the yuan in an attempt to prevent further devaluation and tightened capital controls on financial outflows. O China loosened capital controls to encourage forcign investment into the Chinese economy. O China sold the yuan to encourage further depreciation in an attempt to improve its trade deficit. China's monetary authority sold tie yuan in an attempt to orevent fürther devaluation and raised interest rates to stem the outflow of forcige capital.
Identify the primary actor in the European money market and briefly outlineits main role as participant. Identify also the four primary participants in the foreignexchange market.(b) Suppose that the European Central Bank had the view that the euro is overvalued relative to the dollar (i.e., the nominal exchange rate between the dollar and theeuro, E$/AC, is too high). How should the European Central Bank regulate the Europeannominal money supply to achieve a depreciation of the euro relative to the dollar?(c) Suppose that the dollar interest rate is 3% and the euro interest rate is 0.5%per year and that the interest parity condition holds in the dollar/euro foreign exchangemarket.(i) Explain the relationship between the interest rate difference and the expected appreciation of the euro against the dollar. By how many percentage is the euro expectedto appreciate?(ii) Suppose that the expected future exchange rate is Ee$/AC= 2.05. Obtain the currentequilibrium exchange rate that…
(1) In the IS-LM model, how does an increase in money supply affect theIS curve?(2) According to the Impossible Trinity, if an economy wants to allow for free capitalflows as well as to have full control over its currency, which exchange rate systemshould be adopted?(3) In an IS-LM model, if the investors are suddenly less willing to invest, then what effects does this change make to the equilibrium? Explain your intuitions.(4) According to your answers in (3), if the government wants to stabilize the interestrate using monetary policies, how should it behave? If the government, instead, wantsto stabilize the output level using monetary policies, what is your policy suggestion forit?
2. Suppose both the Fed and the ECB always use the Taylor rule. What happens to the EURUSD exchange rate (number of dollars per euro) today if: a. the inflation differential, which is defined as inflation rate in Europe - inflation rate in USA, increases today? b. it is announced today (time t) that the U.S. real GDP growth rate will increase at t+1?
Suppose a country's central bank announces that it is decreasing the long-run money growth rate to tame inflation. The country's currency will suddenly and its rate of depreciation will then O appreciate; rise O appreciate; fall O depreciate; rise O depreciate; fall
32. The Fisher effect creates a 2 points link between and expected profits; unemployment rates O exchange rates; expected profits O inflation rates; unemployment rates O inflation rates; interest rates
Part 4 5 6 Answer all questions from this section. For each question, identify the statement as True,False, or Uncertain, and explain your reasoning A.1 Following the announcement that the amount of QE intervention by the central bankwill be reduced going forward (also known as Quantitative Tightening), according to theUIP condition, an immediate appreciation of home’s nominal exchange rate would beobserved. A.2 The difference between the slopes of the IS and RX curves depends only on the sensitivityof net exports to the real exchange rate. A.3 Consider a temporary positive inflation shock in a flexible exchange rate regime (with aninflation targeting central bank) and in a fixed exchange rate regime (where there is nopolicy intervention). Assume that both economies converge to a medium run equilibrium.Following the shock, inflation converges to its equilibrium value from above in both cases.A.4 The central bank of a common currency area should not respond to a shock specific toone…

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