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.
To determine if each statement is true or false, we should analyze the given information and apply the relevant economic concepts. Let's break down each statement:
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.
To determine if this statement is true or false, we need to understand the concept of Purchasing Power Parity (PPP). PPP suggests that exchange rates should adjust to ensure an equal purchasing power of different currencies.
In this case, if a pair of American jeans costs 50 dollars in New York and 100 Pounds in London, we can calculate the implied exchange rate. Dividing the price in dollars by the price in pounds, we get 50/100 = 0.5. Therefore, the statement is true.
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.
To determine if this statement is true or false, we need to consider the relationship between money supply and exchange rates. An increase in the money supply generally leads to currency depreciation. This depreciation can create excess demand for the currency of the country experiencing the increase in money supply.
Therefore, if the European money supply increases (assuming all else remains equal), it would likely cause the euro to depreciate against the dollar and create excess demand for dollars in the U.S. money market. Thus, the statement is true.
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.
To determine if this statement is true or false, we need to understand the relationship between money supply, real output, and interest rates. In the long run, changes in the supply of money only affect nominal variables, such as prices and nominal GDP.
However, in the short run, an increase in the money supply can boost real output and decrease interest rates through lower borrowing costs. Therefore, the statement is false in the short run, but true in the long run.
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.
To determine if this statement is true or false, we need to understand the concept of interest rate differentials and exchange rate movements. Assuming perfect arbitrage, which allows for risk-free profit opportunities, an increase in interest rates in a country would attract foreign capital and increase the demand for its currency.
As a result, the exchange rate tends to appreciate since the rate of return on the domestic currency increases. Therefore, the statement is true assuming perfect arbitrage.
5) Suppose Home pegs its 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.
To determine if this statement is true or false, we need to understand the implications of a currency peg and the impact of a positive technology shock. When a country pegs its currency to another currency, it commits to keeping its exchange rate fixed. In this case, if Home pegs its currency to Foreign's currency, it cannot freely adjust its exchange rate.
If Home experiences an unexpected positive technology shock, it would lead to increased productivity and potential economic growth. To maintain the fixed exchange rate, Home would need to provide additional money supply to accommodate the increased economic activity.
Therefore, Home would have to increase its money supply temporarily if it wants to maintain the currency peg after an unexpected positive technology shock. Thus, the statement is true.