I need help on some T/F questions.
1. A decrease in the foreign interest rate results in a shift to the left by the IS curve.
2. Home's trade balance surplus must increase as a result of a decrease in Home's interest rate.
3. Since investment I is a function of nominal interest rate i, investor cares only about the nominal
interest rate, not the real interest rate.
4. An increase in real money demand results in a shift to the right left by the LM curve.
5. It is impossible to have autonomous monetary policy and fixed EX regime simultaneously.
1) I think True. A decrease in foreign interest should cause US investors to invest internationally. (Assuming flexible exchange rates).
2) I think False, same reasoning as in #1
3) Hummmm, I initiall thought false; of course investors care about the real interest rates. However, the answer may be true by assumption. If I=f(r), where I is investment and r is nominal interest, then real interest is not in the equation (except perhaps as a determinant of r). Perhaps I am overanalyzing things.
4) True
5) I will go with false. While it may be very difficult, it may be possible in an extreme case. Consider a world with zero international trade. (e.g, Tahiti before europeans arrived) Then, Tahiti's monetary policy would be meaningles; as too would Tahiti's fixed EX regime policy.
For 2), if decrease in i, cause Exchange rate to depreciate in the foregin exchange market, which makes foreign goods more expensive, thus increaseing export, less import, Trade balance will increase, won't it?
Sure, I can help you with these True/False questions. Let's analyze each statement one by one.
1. A decrease in the foreign interest rate results in a shift to the left by the IS curve.
To determine the accuracy of this statement, we need to understand the relationship between the interest rate and the IS curve. The IS curve shows the combinations of interest rates and output levels where the goods market is in equilibrium.
When there is a decrease in the foreign interest rate, it generally leads to an increase in the net exports of the home country. This is because a lower foreign interest rate makes it cheaper for foreigners to borrow money, increasing their purchasing power for home country goods. As a result, the demand for goods produced by the home country increases, leading to an increase in output (represented by a rightward shift of the IS curve).
Therefore, statement 1 is False. A decrease in the foreign interest rate results in a shift to the right, not the left, by the IS curve.
2. Home's trade balance surplus must increase as a result of a decrease in Home's interest rate.
To determine the accuracy of this statement, we need to understand the relationship between the interest rate and the trade balance surplus.
A decrease in Home's interest rate can lead to several effects on the trade balance surplus. Firstly, a lower interest rate can stimulate domestic investment and consumption, increasing the demand for imports. Secondly, it can lead to a depreciation of the home currency, making exports cheaper and more competitive in international markets, thus increasing the demand for exports.
The net effect of these two effects depends on various factors such as the elasticity of demand for imports and exports, exchange rate movements, and other economic conditions. It is not a guaranteed outcome that Home's trade balance surplus will increase as a result of a decrease in Home's interest rate.
Therefore, statement 2 is False. Home's trade balance surplus could increase or decrease as a result of a decrease in Home's interest rate.
3. Since investment I is a function of nominal interest rate i, investor cares only about the nominal interest rate, not the real interest rate.
To determine the accuracy of this statement, we need to understand the difference between nominal and real interest rates and their influence on investment decisions.
The nominal interest rate is the stated interest rate that is not adjusted for inflation, while the real interest rate is the nominal interest rate adjusted for inflation. Investors make decisions based on the real interest rate because it represents the actual return on investment after accounting for inflation.
When the inflation rate increases, the real interest rate decreases (assuming the nominal interest rate remains constant). In this case, investors may be less willing to invest since their real return on investment is lower. Conversely, when the inflation rate decreases, the real interest rate increases, making investment more attractive.
Therefore, statement 3 is False. Investors care about the real interest rate rather than just the nominal interest rate when making investment decisions.
4. An increase in real money demand results in a shift to the left by the LM curve.
To determine the accuracy of this statement, we need to understand the relationship between real money demand and the LM curve. The LM curve represents the combinations of interest rates and output levels where the money market is in equilibrium.
An increase in real money demand means that individuals and businesses desire to hold more money relative to other assets. If the money supply remains constant, an increase in real money demand would create excess demand for money, leading to an increase in the interest rate required to induce people to hold money.
In this case, the LM curve would shift to the right (not the left) because the higher interest rate reduces overall money demand until it matches the available money supply.
Therefore, statement 4 is False. An increase in real money demand results in a shift to the right, not the left, by the LM curve.
5. It is impossible to have autonomous monetary policy and fixed exchange rate regime simultaneously.
To determine the accuracy of this statement, we need to understand the concepts of autonomous monetary policy and fixed exchange rate regime.
Autonomous monetary policy refers to a situation where a country's central bank has the authority to set and adjust its monetary policy according to the country's economic conditions. This includes controlling interest rates, money supply, and other monetary policy instruments.
A fixed exchange rate regime, on the other hand, is a situation where the value of a country's currency is pegged, or fixed, to another currency or a basket of currencies. In this regime, the central bank aims to maintain the exchange rate within a predetermined range by buying or selling its currency in the foreign exchange market.
Having both autonomous monetary policy and a fixed exchange rate regime simultaneously can be challenging. When a central bank tries to implement its autonomous monetary policy, it may conflict with maintaining a fixed exchange rate. For example, if the central bank decides to lower interest rates to stimulate the economy, it may lead to capital outflows and put downward pressure on the fixed exchange rate. To prevent the exchange rate from depreciating, the central bank may need to intervene in the foreign exchange market by selling its foreign reserves, which could undermine its independence in implementing monetary policy.
Therefore, statement 5 is True. It is generally challenging to have both autonomous monetary policy and a fixed exchange rate regime simultaneously.
Note: It's important to recognize that these statements may vary depending on specific economic models or assumptions. The answers provided here are based on general economic principles.