Deck 18: Macroeconomic Policy and Floating Exchange Rates

Question 1

In an open economy, expansionary fiscal policy causes:

A) interest rates to rise and an inflow of foreign capital.
B) interest rates to fall and an inflow of foreign capital.
C) interest rates to rise and an outflow of foreign capital.
D) interest rates to fall and an outflow of foreign capital.

Answer 1

interest rates to rise and an inflow of foreign capital.

Question 2

In a closed economy, an expansionary monetary policy causes:

A) interest rates to rise and aggregate demand to increase.
B) interest rates to fall and aggregate demand to decrease.
C) interest rates to rise and aggregate demand to decrease.
D) interest rates to fall and aggregate demand to increase.

Answer 2

interest rates to fall and aggregate demand to increase.

Question 3

Explain why governments tend to view internal balance as being more important than external balance.

Answer 3

Governments now tend to use monetary and fiscal policy to focus on a country's internal balance. Internal balance refers to the levels of unemployment and inflation that fit the preferences of the citizens of various economies. For most countries, the focus of fiscal and/or monetary policy is on managing the growth rate of real GDP and the price level. In many cases, this focus on internal balance comes at the expense of external balance considerations. In effect, the exchange rate and the current account balance become secondary variables as countries attempt to manage the domestic economy and the exchange rate and current account balance adjust to these policies. In many cases, this approach seems sensible as the exchange rate and the current account are important. However, the state of the domestic economy is usually considered to be far more important. This focus on internal balance is not without a cost. Policies designed to achieve a desired internal balance may have large consequences for a country's external balance. Governments may not like the results of fiscal and/or monetary policy changes on the country's external balance, but in many cases, they are willing to accept these consequences as the price of maintaining internal balance.

Question 4

Show how a larger government budget deficit tends to lead to an appreciation of the currency.

Question 5

Why is fiscal policy relatively ineffective if exchange rates are allowed to adjust to their equilibrium level?

Question 6

Explain how a government budget's deficit and a current account deficit can be related.

Question 7

If a government wanted a current account surplus, then a government budget deficit would be helpful in achieving that goal. Explain why this statement is true.

Question 8

Show the effects of an expansionary monetary policy on interest rates, the exchange rate, the current account, the capital account, and aggregate demand.

Question 9

A contractionary monetary policy will lead to lower real GDP and the price level when exchange rates are free to find their equilibrium. Explain why this is true.

Question 10

How are lower interest rates caused by an expansionary monetary policy related to an increase in exports and a decrease in imports? What does this have to do with the level of aggregate demand?

Question 11

Describe a consistent mix of monetary and fiscal policies for a country with a current account deficit and a problem with inflation.

Question 12

Describe how an inconsistent policy affects the equilibrium level of output, the price level, interest rates, capital flows, and the exchange rate.

Question 13

Describe what the term "J-curve" means. Why is this concept important?