Exam 6: The Open Economy

Exhibit: Policies Influence Real Exchange Rate Which of the panels illustrates the impact of an increase in investment demand on the real exchange rate?

The real interest rates and real exchanges rates are constant and equal in North Country and South Country. The Fisher equation and purchasing-power parity hold in both countries. If the nominal interest rate is 8 percent in North Country and 10 percent in South Country, do you expect North Country's nominal exchange rate to appreciate, depreciate, or remain the same? Explain.

Suppose that the large industrial countries of the world are concerned about the depreciating currencies of a number of small open economies. a.What type of fiscal policies must the large industrial countries undertake in order to promote currency appreciation in the small open economies? b.Graphically illustrate the impact of the industrial countries' policies on the exchange rate of the small open economies. c.What will happen to the trade balance of the typical small open economy, assuming that it starts from a position of balanced trade?

In a small open economy, if domestic saving equals $50 billion and domestic investment equals $50 billion, then there is _____, and net capital outflow equals _____.

When exports exceed imports, all of the following are true except:

Compare the impact of an increase in the government's budget deficit on investment spending in a small open economy versus in a comparable closed economy. Assume that prices are flexible and that factors of production are fully employed in both economies. Assume that there is perfect capital mobility for the small open economy.

According to purchasing-power parity, if the dollar price of oil is higher in Toronto than in London, arbitrageurs will _____ oil in Toronto and _____ oil in London to drive _____ the price of oil in Toronto.

Why is purchasing power parity called "the law of one price"? Explain.

In a small open economy, if exports equal $5 billion and imports equal $7 billion, then there is a trade _____ and _____ net capital outflow.

If the real exchange rate between Canada and Japan remains unchanged, and the inflation rate in Canada is 6 percent and the inflation rate in Japan is 3 percent, the:

An effective policy to reduce a trade deficit in a small open economy would be to:

In times of great economic uncertainty and potential job loss, many consumers may increase their saving as a precautionary measure. What is the predicted impact of an increase in national saving on the domestic interest rate and exchange rate in a large open economy, holding other factors constant? Illustrate your answer graphically and explain in words.

Assume that a war breaks out abroad, and foreign investors choose to invest more in a large safe country, the United States. Then, the U.S. real interest rate:

The adoption of an investment tax credit in a small open economy is likely to lead to:

Compare the impact of an increase in investment demand in a small open economy and a large open economy. Assume that prices are flexible, factors of production are fully employed in both countries, and there is perfect capital mobility in the small open economy.

Assume that in a small open economy with full employment, national saving is 300. a.If domestic investment is given by I= 400 - 20r, where r is the real interest rate in percent, what would the equilibrium interest rate be if the economy were closed? b.If the economy is open and the world interest rate is 10 percent, what will investment be? c.What will the current account surplus or deficit be? What will net capital outflow be?

If the purchasing-power parity theory is true, then:

If the nominal interest rates in the United States and Canada are 8 percent and 12 percent, respectively, the real interest rates are the same, and the real exchange rate is fixed, then the market's expectation about the number of Canadian dollars to be received for a U.S. dollar a year from now will be that it will:

In a large open economy, the exchange rate adjusts so that net exports equal:

If the information technology boom increases investment demand in a small open economy, then net exports _____, and the real exchange rate _____.