Question 1

Explain the implication for a country’s exchange rate in the monetary approach and in the portfolio balance approach of (a) an autonomous decline in the demand for money at each  interest rate by the country’s citizens, and (b) a change in expectations by the country’s citizens such that less inflation is expected in the future.

Accepted Answer

The monetary approach to exchange rates focuses on the relationship between a country's money supply and its exchange rate. In this approach, an autonomous decline in the demand for money at each interest rate by the country's citizens would lead to an increase in the money supply. This increase in the money supply would result in a depreciation of the country's currency as the increased supply of the currency would lead to a decrease in its value relative to other currencies.

On the other hand, the portfolio balance approach to exchange rates considers the demand for a country's assets by foreign investors. In this approach, a change in expectations by the country's citizens such that less inflation is expected in the future would lead to a decrease in the expected return on domestic assets. This would result in a decrease in the demand for the country's assets by foreign investors, leading to a depreciation of the country's currency as the decreased demand for its assets would lead to a decrease in its value relative to other currencies.

In both approaches, an autonomous decline in the demand for money at each interest rate and a change in expectations regarding future inflation would lead to a depreciation of the country's exchange rate. This would make the country's exports cheaper for foreign buyers, potentially boosting its export sector, but also making imports more expensive for domestic consumers, potentially leading to higher inflation.

Question 2

If M_s is the money supply, BR = reserves of commercial banks (depository institutions), C = currency held by the nonbank public, and a = the money multiplier, then A) M_s = aBR + C B) M_s = a(BR + C) C) BR = M_s - C D) aC = M_s - BR

Accepted Answer

The equation for the money supply is MS = (currency held by nonbank public) + (demand deposits at depository institutions) = C + D. The reserves of commercial banks (depository institutions) are the amount of money that banks keep on hand to meet withdrawal demands from their customers. This includes both required reserves (which banks must keep to meet regulations) and excess reserves (which banks choose to keep above the required amount). Banks lend out the excess reserves to create more money in the form of loans, which then become deposits in other accounts. The money multiplier, a, represents the amount by which the money supply is multiplied when banks create new money by lending out excess reserves. Therefore, the equation that relates these variables in the most accurate way is M_s = a(BR + C).

Question 3

In the monetary approach to the exchange rate, which one of the following will cause a depreciation of A's currency relative to B's currency?
A) an increase in the amount of money demanded at each income level in country B
B) an increase in the money supply in country B
C) a fall in real income in country B
D) a decrease in the money supply in country A

Accepted Answer

A

Question 4

Describe a scenario that will make the current three-months forward rate on a foreign currency equal to the expected spot rate in three months for that currency. What might prevent this result from occurring?

Accepted Answer

The answer of Describe a scenario that will make the...

Question 5

Why do the monetary approach and the portfolio balance approach have different expected signs for the impact of a change in the domestic interest rate on the exchange rate? Explain carefully.

Accepted Answer

The answer of Why do the monetary approach and the...

Question 6

In considering the demand for money in the monetary approach to the balance of payments, it can be said that the money demand would increase if home real income __________ and if the home interest rate __________.
A) decreases; also decreases
B) decreases; increases
C) increases; decreases
D) increases; also increases

Accepted Answer

The demand for money typically increases when home real income increases because people have more income to hold in the form of money for transactions and other purposes. Additionally, the demand for money decreases when the home interest rate increases because higher interest rates make holding money less attractive compared to other interest-bearing assets.

Question 7

In the monetary approach to the balance of payments, under flexible exchange rates, an Increase in the proportion of income that people in country A wish to hold as money Would, other things equal, lead to an __________ in country A's balance of payments and Therefore to __________ of A's currency in the foreign exchange markets.
A) incipient surplus; a depreciation
B) incipient surplus; an appreciation
C) incipient deficit; a depreciation
D) incipient deficit; an appreciation

Accepted Answer

When people in country A wish to hold a larger proportion of their income as money, they reduce their spending on goods and services, including imports. This reduction in imports improves the balance of payments, leading to an incipient surplus. As demand for country A's currency increases to purchase its now relatively cheaper goods and services, the currency appreciates in the foreign exchange markets.

Question 8

In the monetary approach to the exchange rate, a decrease in income in country I Will, other things equal, lead to an __________ money in country I and therefore to __________ of country I's currency against other currencies.
A) excess supply of; a depreciation
B) excess supply of; an appreciation
C) excess demand for; a depreciation
D) excess demand for; an appreciation

Accepted Answer

A decrease in income in country I will lead to a decrease in the demand for money in country I, which will lead to an excess supply of money in country I. This will lead to a depreciation of country I's currency against other currencies.

Question 9

Which one of the following, other things equal, would NOT cause an increase in the Amount of money demanded in country A?
A) an increase in A's national income
B) an increase in the price level in country A
C) a fall in interest rates in country A
D) an increase in the rate of expected inflation in A

Accepted Answer

An increase in the rate of expected inflation in country A would actually encourage people to spend or invest their money rather than hold onto it, as the value of money is expected to decrease over time with inflation. This would not increase the demand for holding money.

Question 10

If i_d is the domestic interest rate, i_f is the foreign interest rate, xa is the expected rate of appreciation of the foreign currency (or the expected rate of depreciation of the home currency), and financial capital is mobile across countries (and assuming no risk premium), then equilibrium in international financial asset markets is indicated by the expression A) xa = (i_d/i_f). B) xa = i_d + i_f. C) i_f = i_d + xa. D) i_d = i_f + xa

Accepted Answer

The correct expression for equilibrium in international financial asset markets, given the assumptions, is that the domestic interest rate (i_d) equals the foreign interest rate (i_f) plus the expected rate of appreciation of the foreign currency (xa). This reflects the interest rate parity condition, where any difference in interest rates between two countries is offset by the expected change in exchange rates, ensuring no arbitrage opportunities exist.

Question 11

In the Dornbusch "overshooting" model, asset markets adjust __________ rapidly to disturbances than do goods markets, and therefore the exchange rate and the price level __________ proportionately to each other in the short run.
A) more; move
B) more; do not move
C) less; move
D) less; do not move

Accepted Answer

The answer of In the Dornbusch "overshooting" model, asset markets...

Question 12

In the monetary approach to the balance of payments and the exchange rate,
A) an increase in the demand for money (with a fixed supply) would cause a balance-of-Payments deficit under fixed exchange rates.
B) an increase in the supply of money (with a fixed demand) would cause a balance- Of-payments surplus under fixed exchange rates.
C) a decrease in the demand for money (with a fixed supply) would cause a balance-of- Payments deficit under fixed exchange rates.
D) an increase in the supply of money (with a fixed demand) would cause the domestic Currency to appreciate under flexible exchange rates.

Accepted Answer

A decrease in the demand for money, with a fixed supply, leads to excess money in the economy, causing a balance-of-payments deficit under fixed exchange rates as people convert excess domestic currency into foreign currency.

Question 13

in the expected rate of depreciation of the home currency)
12.	The term xa in the textbook is defined as the expected rate of appreciation of the foreign currency.  A mathematical way to express this definition [where e is the spot rate of the foreign currency and E(e) is the expected future spot rate of the foreign currency] is __________.
A) E(e) - e
B) 
$\frac { e } { E ( e ) }$
C) 
$\frac { E ( e ) - 1 } { e }$
D) 
$\frac { E ( e ) - e } { e - 1 }$

Accepted Answer

The formula that expresses xa (the expected rate of appreciation of the foreign currency) is E(e)/e - 1, which is equivalent to answer C. This can be derived by starting with the formula for the percentage change in the spot rate:
[(E(e) - e)/e] * 100%
Then, dividing both sides by 100% and factoring out e in the numerator gives:
E(e)/e - 1
Therefore, answer C is the correct choice.

Question 14

(a) Could there be "overshooting" of the exchange rate in the Dornbusch model if goods markets adjusted as rapidly as asset markets? Why or why not?
(b) What would be the analog to the general phenomenon of "overshooting" in a situation of fixed exchange rates?

Accepted Answer

The answer of (a) Could there be "overshooting" of the...

Question 15

In the monetary approach to the balance of payments and the exchange rate, if there is an excess demand for money, the result is a balance-of-payments __________ in a fixed exchange rate situation and __________ of the country's currency in a flexible exchange Rate situation.
A) surplus; an appreciation
B) surplus; a depreciation
C) deficit; an appreciation
D) deficit; a depreciation

Accepted Answer

In the monetary approach, an excess demand for money implies that people are trying to hold more money than is available. In a fixed exchange rate system, this leads to a balance-of-payments surplus as domestic currency is in high demand, and in a flexible exchange rate system, it leads to an appreciation of the currency as the demand for the currency increases.

Question 16

In the portfolio balance model, other things equal, the issuance of new bonds by a home corporation will __________ the domestic interest rate and, especially if home and Foreign bonds are very good substitutes for each other, will lead to __________ of the Home currency.
A) decrease; a depreciation
B) decrease; an appreciation
C) increase; a depreciation
D) increase; an appreciation

Accepted Answer

The answer of In the portfolio balance model, other things...

Question 17

In the asset market or portfolio balance approach, other things equal, a depreciation of the home currency would be caused by __________ in inflationary expectations in the home country and by __________ in real income in the home country.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease

Accepted Answer

An increase in inflationary expectations in the home country would lead to a depreciation of the home currency because investors would demand higher returns to compensate for the expected loss in purchasing power, making domestic assets less attractive. A decrease in real income in the home country would also lead to a depreciation of the home currency because it would imply lower economic growth prospects, making domestic assets less attractive to investors.

Question 18

In the portfolio balance approach, which one of the following, other things equal, will cause an increase in the demand for domestic bonds by home country citizens?
A) a decrease in the home country interest rate
B) a increase in the home country price level
C) an increase in the home country real income level
D) a decrease in the expected rate of appreciation of the foreign currency (or a decrease In the expected rate of depreciation of the home currency)

Accepted Answer

A decrease in the expected rate of appreciation of the foreign currency (or a decrease in the expected rate of depreciation of the home currency) will make domestic bonds more attractive relative to foreign bonds, leading to an increase in demand for domestic bonds by home country citizens.

Question 19

In a situation of a fixed exchange rate, explain why, in the monetary approach, an excess supply of money leads to a balance-of-payments deficit. Why is the deficit only temporary? How might advocates of the monetary approach explain a long-lasting deficit in the balance of payments?

Accepted Answer

The answer of In a situation of a fixed exchange...

Question 20

Suppose that, for a country, its money supply (M^s) is at the moment equal to its demand for money (M^d). Now suppose that the country's central bank pumps new money into the economy. The result of this central bank action, other things equal, is that there will be __________ under flexible exchange rates and a consequent __________ of the country's currency. A) an incipient balance-of-payments surplus for the country; appreciation B) an incipient balance-of-payments surplus for the country; depreciation C) an incipient balance-of-payments deficit for the country; appreciation D) an incipient balance-of-payments deficit for the country; depreciation

Accepted Answer

An increase in the money supply will lead to an increased demand for goods and services, which will cause inflation. As a result, imports will be cheaper than domestic goods, leading to an increase in imports and a decrease in exports. This will result in a balance-of-payments deficit and a depreciation of the country's currency.

Quiz 22: The Monetary and Portfolio Balance Approaches to External Balance

If M_s is the money supply, BR = reserves of commercial banks (depository institutions) , C = currency held by the nonbank public, and a = the money multiplier, then

In the monetary approach to the exchange rate, which one of the following will cause a depreciation of A's currency relative to B's currency?

Describe a scenario that will make the current three-months forward rate on a foreign currency equal to the expected spot rate in three months for that currency. What might prevent this result from occurring?

Why do the monetary approach and the portfolio balance approach have different expected signs for the impact of a change in the domestic interest rate on the exchange rate? Explain carefully.

In considering the demand for money in the monetary approach to the balance of payments, it can be said that the money demand would increase if home real income and if the home interest rate .

In the monetary approach to the exchange rate, a decrease in income in country I Will, other things equal, lead to an money in country I and therefore to of country I's currency against other currencies.

Which one of the following, other things equal, would NOT cause an increase in the Amount of money demanded in country A?

In the Dornbusch "overshooting" model, asset markets adjust rapidly to disturbances than do goods markets, and therefore the exchange rate and the price level proportionately to each other in the short run.

In the monetary approach to the balance of payments and the exchange rate,

(a) Could there be "overshooting" of the exchange rate in the Dornbusch model if goods markets adjusted as rapidly as asset markets? Why or why not? (b) What would be the analog to the general phenomenon of "overshooting" in a situation of fixed exchange rates?

In the monetary approach to the balance of payments and the exchange rate, if there is an excess demand for money, the result is a balance-of-payments in a fixed exchange rate situation and of the country's currency in a flexible exchange Rate situation.

In the portfolio balance model, other things equal, the issuance of new bonds by a home corporation will the domestic interest rate and, especially if home and Foreign bonds are very good substitutes for each other, will lead to of the Home currency.

In the asset market or portfolio balance approach, other things equal, a depreciation of the home currency would be caused by in inflationary expectations in the home country and by in real income in the home country.

In the portfolio balance approach, which one of the following, other things equal, will cause an increase in the demand for domestic bonds by home country citizens?

In a situation of a fixed exchange rate, explain why, in the monetary approach, an excess supply of money leads to a balance-of-payments deficit. Why is the deficit only temporary? How might advocates of the monetary approach explain a long-lasting deficit in the balance of payments?

Quiz 22: The Monetary and Portfolio Balance Approaches to External Balance

If Ms is the money supply, BR = reserves of commercial banks (depository institutions) , C = currency held by the nonbank public, and a = the money multiplier, then

In the monetary approach to the exchange rate, which one of the following will cause a depreciation of A's currency relative to B's currency?

Describe a scenario that will make the current three-months forward rate on a foreign currency equal to the expected spot rate in three months for that currency. What might prevent this result from occurring?

Why do the monetary approach and the portfolio balance approach have different expected signs for the impact of a change in the domestic interest rate on the exchange rate? Explain carefully.

In considering the demand for money in the monetary approach to the balance of payments, it can be said that the money demand would increase if home real income __________ and if the home interest rate __________.

In the monetary approach to the exchange rate, a decrease in income in country I Will, other things equal, lead to an __________ money in country I and therefore to __________ of country I's currency against other currencies.

Which one of the following, other things equal, would NOT cause an increase in the Amount of money demanded in country A?

In the Dornbusch "overshooting" model, asset markets adjust __________ rapidly to disturbances than do goods markets, and therefore the exchange rate and the price level __________ proportionately to each other in the short run.

In the monetary approach to the balance of payments and the exchange rate,

(a) Could there be "overshooting" of the exchange rate in the Dornbusch model if goods markets adjusted as rapidly as asset markets? Why or why not? (b) What would be the analog to the general phenomenon of "overshooting" in a situation of fixed exchange rates?

In the monetary approach to the balance of payments and the exchange rate, if there is an excess demand for money, the result is a balance-of-payments __________ in a fixed exchange rate situation and __________ of the country's currency in a flexible exchange Rate situation.

In the portfolio balance model, other things equal, the issuance of new bonds by a home corporation will __________ the domestic interest rate and, especially if home and Foreign bonds are very good substitutes for each other, will lead to __________ of the Home currency.

In the asset market or portfolio balance approach, other things equal, a depreciation of the home currency would be caused by __________ in inflationary expectations in the home country and by __________ in real income in the home country.

In the portfolio balance approach, which one of the following, other things equal, will cause an increase in the demand for domestic bonds by home country citizens?

In a situation of a fixed exchange rate, explain why, in the monetary approach, an excess supply of money leads to a balance-of-payments deficit. Why is the deficit only temporary? How might advocates of the monetary approach explain a long-lasting deficit in the balance of payments?

If M_s is the money supply, BR = reserves of commercial banks (depository institutions) , C = currency held by the nonbank public, and a = the money multiplier, then

In considering the demand for money in the monetary approach to the balance of payments, it can be said that the money demand would increase if home real income and if the home interest rate .

In the monetary approach to the exchange rate, a decrease in income in country I Will, other things equal, lead to an money in country I and therefore to of country I's currency against other currencies.

In the Dornbusch "overshooting" model, asset markets adjust rapidly to disturbances than do goods markets, and therefore the exchange rate and the price level proportionately to each other in the short run.

In the monetary approach to the balance of payments and the exchange rate, if there is an excess demand for money, the result is a balance-of-payments in a fixed exchange rate situation and of the country's currency in a flexible exchange Rate situation.

In the portfolio balance model, other things equal, the issuance of new bonds by a home corporation will the domestic interest rate and, especially if home and Foreign bonds are very good substitutes for each other, will lead to of the Home currency.

In the asset market or portfolio balance approach, other things equal, a depreciation of the home currency would be caused by in inflationary expectations in the home country and by in real income in the home country.