“According to the asset approach to the exchange rate, there will be an overshooting of domestic currency when there is a once-and-for-all increase in foreign money demand.  However, this change in foreign money demand will have no effect on the domestic balance of payments in both short run and long run.”  True/False/Uncertain, explain with the support of ONE foreign exchange market diagram.

 

Note: 

• Quote the exchange rate as EDC/FC.
• DO NOT write “let Foreign be the home country and its currency be DC” and start your analysis; otherwise, you will receive a grade of ZERO for the whole question.

Compare your answer to initial long-run equilibrium.

We define real exchange rate as the relative price of domestic goods to foreign goods in domestic currency and we define nominal exchange rate as the amount of domestic currency necessary to exchange for 1 unit of forein currency. When real exchange rate increases without changing domestic and foreign prices, how does nominal exchange rate change?

Assume the central bank engages in aggressive open market purchases in an effort to stimulate the domestic economy. The nation has flexible exchange rates and the central bank does not intervene in the foreign exchange markets.

a) The change in R causes foreign money to flow (into or out of) the nation. This causes the domestic currency to (appreciate or depreciate).

b) The combined effect of changes in R, PI and RGDP causes the domestic currency to (appreciate or depreciate).

c) The depreciation of the domestic currency will tend to (increase or decrease) exports and NE but the changes in PI and RGDP will (increase or decrease) NE. The net result will be an (increase or decrease) in NE.

d) NE will tend to (support or oppose) the goal of stimulating the nation’s economy.

6) Which of the following would be the most pessimistic with regard to the ability of the government to reduce unemployment by monetary of fiscal policy? a. Monetarists b. Keynesians c. rational expectations school d. Klingons e. supply-siders

7) Which of the following would tend to increase a country's imports?

a. an increase in the domestic rate of interest

b. an increase in the exchange rate ( i.e an increase in the price of foreign exchange)

c. an increase in domestic income

d. an increase in foreign prices

e. none of the above

8) Which of the following would decrease a country's exports ?

a. a decrease in the exchange rate( i.e a an decrease in the price of foreign exchange)

b. an increase in the domestic rate of interest

c. an increase in domestic price

d. an increase in domestic income

e. none of the above

9) Which of the following would indicate a conflict between the goals of full employment and balance of payments equilibrium ?

a. inflation and a balance of payments deficit

b. unemployment and a balance of payments surplus

c. unemployment and a balance of payments deficit

d. full employment and a balance of payments surplus

e. none of the above would indicate a conflict

10) Which of the following would result if the county's currency depreciated ? a. an increase in both imports and exports

b. a decrease in both imports and exports

c. an increase in imports and a decrease in exports

d. a decrease in imports and an increase in exports

e. a decrease in net capital inflows

11) Under the gold standard, if a nation had a balance of payments surplus, the difference would have been resolved by:

a. gold shipments from the surplus to the deficit country

b.gold shipments from the deficit to the surplus country

c. appreciation of the country's currency in the foreign exchange markets

d. depreciation of the country's currency in the foreign exchange markets

e. human sacrifices in the deficit country

12.Under a system of flexible exchange rates, if a nation had a balance of payments deficit, which of the following would occur ?

a. gold shipment from the surplus to the deficit country

b. gold shipments from the deficit to the surplus country

c. appreciation of the current in the foreign exchange markets

d. depreciation of the currency in the foreign exchange markets

e. the money supply increase

13. Depreciation of a country's currency would generally result in:

a. the aggregate demand curve shifting to the left

b. the aggregate demand curve shifting to the right

c. the aggregate supply curve shifting to the left

d. the aggregate supply curve shifting to the right.

e) both A and B