ECON 3430 Lecture Notes - Lecture 19: Special Drawing Rights, Deflation, Monetary Base

The national government increases spending and lowers taxes in an effort to raise RGDP and lower the unemployment rate. However, the budget deficit is increased, so the treasury borrows funds to finance the higher deficit. The country has fixed exchange rates with the US dollar which the central bank maintains through aggressive intervention in the foreign exchange market.

a) If capital mobility is high, the domestic currency will (appreciate or depreciate). The central bank must purchase (dollars or pesos) to maintain the fixed exchange rate. This effect will (support or counter) the goal of stimulating the nation’s economy.

b) The Impossible Trinity holds that a nation can achieve any 2 of 3 goals. List the 3 goals:

1.

In an open economy with global capital markets and mobile capital:

A) a country has control over both its domestic money supply and exchange rate.

B) a country has control of either its domestic money supply or exchange, but not both.

C) a country only has control over its domestic money supply.

D) a country only has control over its exchange rate.

2.

An overvalued fixed exchange rate can be maintained only as long as:

A) the country's central bank reserves are available to support currency intervention in the foreign exchange market.

B) the country's central bank can increase the domestic money supply.

C) the country's government increases debt financing.

D) none of the above.

3.

The decrease in demand faced by McDonald's during 2001-2002 can be attributed to:

A) decrease in consumer preference for high-fat content food.

B) increase in lawsuits.

C) increase in competitive pressures.

D) all of the above.

Foreign Monetary Policy
Suppose the People's Bank of China wishes to peg the rate of exchange of its currency, the Yuan, in terms of the U.S. dollar. In each of the following situations, should it add to or subtract from its dollar foreign exchange reserves? Why?

a.U.S. parents worrying about safety begin buying fewer Chinese-made toys for their children.

b.U.S. interest rates rise relative to the interest rates in China; therefore, the Chinese residents seek to purchase additional U.S. financial assets.

c.The Chinese furniture manufacturers produce high-quality early American furniture and successfully export large quantities of the furniture to the United States.