Question 1

Explain the cases for and against flexible and fixed exchange rate regimes.

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Question 2

Suppose output is above the natural level of output. In a fixed exchange rate regime, explain the two ways the economy can return to the natural level of output.

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Question 3

Suppose the economy is operating below the natural level of output. Discuss the arguments for and against using a devaluation in such a situation.

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Question 4

What is an "optimal currency area"? Also, discuss the conditions that must be satisfied for an optimal currency area to exist.

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Question 5

First, briefly explain why the AD curve is downward sloping in a closed economy. Second, briefly explain why the AD curve is downward sloping in an open economy under fixed exchange rates. And finally, briefly compare the size of the slopes of the two AD curves.

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Question 6

Explain what factors cause shifts of the aggregate demand curve in the open economy model.

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Question 7

Explain why exchange rates are more volatile than is suggested by the relatively simply interest parity condition presented earlier in the course.

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Question 8

Assume that exchange rates are flexible and that the future expected exchange rate in one year is not constant. Suppose that individuals now expect that the domestic central bank will pursue contractionary monetary policy in one year. This expected future monetary contraction will cause which of the following to occur?
A) The current nominal exchange rate will decrease.
B) The current nominal exchange rate will increase.
C) The current nominal exchange rate will not change.
D) The effects on the current nominal exchange rate are ambiguous.
E) The effects on the current nominal exchange rate depend on future current account balances.

Accepted Answer

When individuals expect a domestic central bank to pursue contractionary monetary policy in the future, it typically leads to expectations of higher interest rates in the future. Higher future interest rates make the domestic currency more attractive to investors, as they anticipate higher returns on investments denominated in that currency. This increased demand for the domestic currency in anticipation of the policy leads to an appreciation of the currency now, hence the current nominal exchange rate increases.

Question 9

Explain why the nominal exchange rate must overshoot in the short run when the central bank pursues monetary expansion by lowering the price target?

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Question 10

Assume a country is in a fixed exchange rate regime. Explain what factors might cause individuals to expect that a country will revalue its currency.

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Question 11

Suppose the economy is initially operating below the natural level of output. In a fixed exchange rate regime, explain how the economy will adjust to this situation.

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Question 12

When we no longer assume that the future expected exchange rate in one year is constant, explain what variables affect the current exchange rate in a flexible exchange rate regime. Include in your answer an explanation of how changes in these variables affect the current exchange rate.

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Question 13

Assume a country is in a fixed exchange rate regime. Now suppose that individuals expect that policy makers will revalue its currency. Explain the various actions that policy makers can choose in response to this expected revaluation.

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