Deck 15: Money, Interest Rates, and the Exchange Rate

Question 1

In the U.S. what are the components of M1 and M2? What is the difference between the two?

Answer 1

The sum of currency plus demand deposits is referred to as the money supply. In the U.S., the total quantity of currency plus demand deposits is called M1. Internationally, this definition of the money supply is known as narrow money. For the most part, near-monies do not function as a medium of exchange but they can be readily converted into currency or demand deposits. For the U.S., M1 plus money market mutual funds and time deposits constitutes M2. In an international context, the term for M2 is called broad money.

Question 2

In every country, it is perfectly obvious what the supply of money is. Explain why this statement is either true or false.

Answer 2

False

Question 3

If the interest rate on a comparable investment in Japan and Germany were 2 and 4 percent, respectively, then the Japanese yen would be expected to depreciate in value against the Euro.

Answer 3

True

Question 4

What is the relationship among the monetary base, the money multiplier, and the money supply?

Question 5

If the central bank raises the discount rate the supply of money would tend to fall. Carefully explain why this statement would be true.

Question 6

Central banks do not frequently change the reserve requirement because the effects on the money supply may be too large. Explain why this is true.

Question 7

Suppose that the price level increased, interest rates increased, and incomes fall. What would happen to the demand for money?

Question 8

Show what would happen if the central bank increased the supply of money at the same time the demand for money fell.

Question 9

Explain why interest arbitrage is important in determining capital flows between countries.

Question 10

Explain how capital flows affect the exchange rate and the current account balance.