Questions for Review

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Questions for Review

I suggest you write out answers to the following questions, looking back at your book only afterward to check yourself. The questions on the exam also may ask you to apply the concepts here to particular situations.
Chapter 12: National Income Accounting and Balance of Payments

  1. Write the national income account identity for an open economy. Define the components.

  1. Use the above to show that national saving does not need to equal national investment.

  1. Use the above to show the relationship between the government budget deficit and the current account deficit.

  1. Under what conditions might a large current account deficit be justified?

  1. In balance of payments accounting, list the components of the current account balance and the capital account balance.

Chapter 13: Foreign Exchange Market

  1. Define the following: forward exchange rate, swap, futures contract, currency call option.

  1. In words, characterize the difference between the asset approach to exchange rate determination and the monetary approach.

  1. Write the interest parity condition, and explain why it holds as an equilibrium condition for the foreign exchange market.

  1. Draw a graph of this market, and explain how it corresponds to the interest parity condition.

  1. How is covered interest parity different from the above?

Chapter 14: Money, Interest Rates, and Exchange rates

  1. Why is money demand a function of the interest rate and output?

  1. How is equilibrium in the money market achieved in the short run? Draw a graph.

  1. Combine graphs for the money market and foreign exchange market (interest rate parity), and use it to tell the short-run story of a temporary increase in money supply.

  1. What is the equilibrium approach to exchange rates?

  1. Combine the monetary and asset approach to tell the story of a permanent increase in money supply.

  1. Why do we get exchange rate overshooting? What is the role of the interest parity condition in this? Of prices that adjust slowly?

Chapter 15: Price levels and the Exchange rate in the Long Run

  1. What is the law of one price, and under what three conditions does it hold?

  1. What is PPP, and under what four conditions does it hold?

  1. What are the predictions of the monetary approach for exchange rates and price level from a money supply increase?

  1. What is the real exchange rate?

Chapter 16: Output and the Exchange Rate in the Short Run (AA and DD Curves)

  1. Show in a graph equilibrium in the goods market, as aggregate demand equal production.

  1. Use this graph to derive the DD curve. Why does the DD curve have a positive slope?

  1. List four things that could shift the DD curve to the right.

  1. Use the asset market graph to derive the AA curve? Why does the AA curve have a negative slope?

  1. How is equilibrium achieved jointly in the asset and goods markets?

  1. Graph and tell the story of a temporary increase in money supply.

  1. Do the same for a temporary fiscal policy.

  1. Show a taste shock. Show how monetary and fiscal policy could be used to keep equilibrium output from changing. What is the difference between the two policies?

  1. Do the same for a money demand shock.

  1. Graph and tell the story of a permanent increase in money supply.

  1. Graph and tell the story of a permanent increase in government expenditure.

  1. What does an XX curve represent? Use it to show what happens to the current account under a monetary expansion. What about with a fiscal expansion?

  1. How does the effect of monetary policy change if consumption and/or investment demand are functions of the interest rate?

  1. Explain the J-curve.

Chapter 17: Fixed Exchange Rates

  1. How does a central bank intervene in the foreign exchange market to keep the market exchange rate at the officially fixed level?

  1. Use a central bank balance sheet to show a sale of foreign reserves. What will this do to the money supply?

  1. Why can’t monetary policy be used under a fixed exchange regime?

  1. Use the AA-DD graph to depict a temporary fiscal policy under fixed exchange rates. Use the asset market graph to show what happens to the money supply and interest rate.

Chapter 18: History of Fixed Exchange Rates

  1. List all the benefits of fixed exchange rates, and all the costs.

  1. What is the difference between internal and external balance?

  1. How did U.S. policy during the 1970s undermine the Bretton Woods system?

  1. What are the steps of a currency crisis?

Chapter 19: Macroeconomic Policy and Coordination under Floating Exchange Rates

  1. Give an explanation for why the dollar had a high value in the 1980’s.

  1. How can governments affect the equilibrium exchange rate just by making announcements of their intentions?

  1. Describe the coordination issues. What are the advantages and disadvantages of fixed and floating exchange rates? Think about what you think might be the best policy (and when and why).

Chapter 20: EMS and EMU

    1. What are the differences between the mechanics of the EMS and the Bretton Woods system?

    1. Explain how German policies after unification caused trouble for its neighbors. How did this spark a currency crisis in 1992?

    1. What are the main differences between the current condition of economies in Europe and that of the U.S. economy?

    1. What factors determines an optimal currency area? How do these apply to Europe? What does the future look like?

    1. What are the four Maastricht Criteria, and how well are the being satisfied?

Chapter 21: International Capital Markets

  1. What is the benefit of intertemporal trade?

  1. What is the benefit of portfolio diversification?

  1. How are Eurocurrencies created, and what effect do they have on the money supply?

  1. Why is international banking difficult to regulate?

Chapter 22: Developing Country Issues

    1. What is seigniorage?

    1. Describe the causes of the Mexican debt crisis of the 1980’s.

    1. Describe the Brady plan.

    1. How has the role of the IMF changed from under the Bretton Woods system?

    1. How does a program of inflation stabilization typically work?

    1. Discuss currency boards and dollarization.

    1. Contrast the Asian and Latin American crises.

    1. What measures do you think would be beneficial with respect to the functioning of the international capital market vis-à-vis developing countries?

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