posted by Leo on .
I am not quite sure about the following questions, is it True or False for each of the following?
1) The exchange rate (under PPP) between the dollar and the British pound would be 0.5 dollars per
British pound if a pair of American jeans costs 50 dollars in New York and 100 Pounds in London.
2) Given P (of US) and Y(of US), an increase in the European money supply causes the euro to depreciate against
the dollar, and it creates excess demand for dollars in the U.S. money market.
3) All else equal, a change in the level of the supply of money has no effect on values of real output and
the interest rate.
4) Assuming perfect arbitrage all the time and all else equal, an increase in interest rates results in an
exchange rate appreciation since the rate of return on domestic currency increases.
5) Suppose Home pegs it currency to Foreign's currency and both countries allow free movement of capital. Then Home has to increase its money supply temporarily if Home has an unexpected positive technology shock.
Thanks in advance.
first off, international macro is not my area, That said....
1) you have given 50$=100L (in jeans). So, under PPP, 0.5$=1L (so true). (Note: in the real world, the exchange rate is closer to 1$=.5L)
2) I think True. If the euro depreciates against the $, then money investors will want to unload their euros in exchange for $,
3) False -- the interest rate is the price of money.
4) I can think of a case where this is false. If interest rates rise as a result of inflation or expected inflation, then the rate of return on domestic currenty would decrease.
5) Sounds true. If a positive technology shock causes both Home and Foreign to want to invest in Home -- Causing an increase in demand for Home currency, causing pressure to increase the price of Home's currency relative to Foreign. So, to maintain the pegged exchange rate, Home must increase it's money supply.
Thanks economyst, I'll look into these more.