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EXAM II, ECON 457

SPRING 2016
March 10, 2016
Each multiple choice question is worth four points.
NAME

UID

A)
B)
C)
D)

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?
the spot rate to purchase euros would rise (dollar depreciation).
the spot rate to purchase euros would fall (dollar appreciation).
the spot rate to purchase euros would be unchanged.
the U.S. Federal Reserve would have to raise U.S. short-term interest rates.

A)
B)
C)
D)

2. At higher nominal rates of interest, the demand for real balances is:
higher because savers can earn higher returns.
lower because the opportunity cost of holding those funds is higher.
invariant with respect to the nominal interest rate.
inversely related to the price level.

D)

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?
U.S. nominal and real returns rates decline while euro rates hold steady, and the U.S.
dollar depreciates against the euro.
U.S. nominal returns rise, U.S. real returns fall, euro rates rise, and the U.S. dollar
appreciates against the euro.
U.S. nominal returns fall, U.S. real returns rise, euro rates fall, and the U.S. dollar
appreciates against the euro.
U.S. dollar returns and euro returns both rise, leaving the exchange rate unchanged.

A)
B)
C)
D)

4. When there is a permanent fall in the domestic money supply, the exchange rate:
falls in the short run and rises slightly in the long run.
falls in the short run and falls more in the long run.
rises in the short run and falls slightly in the long run.
rises in the short run and rises more in the long run.

A)
B)
C)
D)

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?
Prices will decrease by 8%.
Prices will increase by 4%.
The home country currency will depreciate by 8%.
The home country currency will appreciate by 4%.

A)
B)
C)

A)
B)
C)
D)
A)
B)
C)
D)

6. With fixed exchange rates and capital mobility:


interest rates in the home country and in foreign countries are equalized.
interest rates in the home country are higher.
interest rates in foreign countries are higher.
monetary policy maintains its autonomy.
7. If an economy wants to maintain monetary policy autonomy, then:
it can maintain a fixed exchange rate and international capital mobility.
it can impose strict capital controls and maintain a fixed exchange rate.
it can maintain capital mobility but not a fixed exchange rate.
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

A)
B)
C)
D)

8. (Table: Hypothetical Canadian National Income and Product Accounts Data) The GNE is
_______.
$630
$550
$230
$120

A)
B)
C)
D)

9. (Table: Hypothetical Canadian National Income and Product Accounts Data) The trade balance
for the economy provided is ______.
$60
$150
$150
$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

A)
B)
C)
D)

10. (Table: Hypothetical Irish National Income and Product Accounts Data) What is the current
account for Ireland?
$310
$290
$290
$410

A)
B)
C)
D)

11. If investment exceeds national savings, then the current account:


must be negative.
must be zero.
must be positive.
not enough information

A)
B)
C)
D)

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:
imports of goods with a minus (debit) and exports of goods with a plus (credit).
imports of goods with a minus (debit) and exports of financial assets with a plus (credit).
exports of goods with a minus (debit) and imports of financial assets with a plus (credit).
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.

A)
B)
C)
D)

14. Nominal interest rates are considered to be _____ in the short-run model.
flexible
rigid
zero
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.
A)
B)
C)
D)

16. Asset exports occur when domestic entities:


save internationally by purchasing foreign assets.
borrow internationally by selling assets to foreigners.
increase savings and decrease spending both domestically and internationally.
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 A longer march suggests that
A) China should move towards more openness in its financial markets in order to
become a world economic power
B) The recent setbacks in Chinese economy have scuttled its progress towards becoming a
dominant power
C) China should behave more responsibly in South China sea and not flare up fears among its
smaller neighbors.
D) China should move to a multi-party democracy

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
years 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. Now suppose that in the above problem the money supply increase was permanent. The
exchange rate still rises on impact. In the short run, does it rise more or less than in the previous
case? Then, over time, does it rise or fall? How is this appreciation or depreciation dollar over
time consistent with UIP? (4 points)
Answer: In case of permanent monetary increase, the future (expected) exchange rate increases
from its current level (due to long run PPP), and as a result FR also shifts to the right in the Forex
market. In the short run, exchange rate depreciates at the intersection of DR (2) and the newly
shifted FR. In the long run, DR moves back up, and exchange rate appreciates over time.
Since the current dollar interest rate falls on monetary expansion, the arbitrage requires that
dollar appreciate over time. This is consistent with the exchange rate first overshooting (rising
beyond) its expected future rate and then fall (appreciate) over time.

23. In each of the following cases what specific entries will occur in the balance of payments
accounts? (6 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

c. Starbucks sells its franchises in India worth $50 million.


KA: rights transfer +$50
FA: Import of Indian deposits -$50

24. Does a country with a positive Financial Account increase or decrease its external wealth?
What are the other balance-sheet factors that can aggravate/offset such changes in external
wealth? (4 points)
Answer: A positive entry means a net export of assets. The countrys external wealth decreases as
a result. Capital gains and exchange rate valuation effects may either offset the decrease in
wealth or further lower it.

25. Based on NY Times report Negative interest rates: The report is organized by answering
various questions about the modus operandi and efficacy of negative interest rates. One of the
questions is Does it Work? What is the answer? (Bonus question: 4 points)
Its hard to say with any certainty yet. It seems to have an effect of lowering
the value of a currency, which makes export industries very happy. Its less
clear whether it can help create sustained economic growth.