Deck 22: The Monetary and Portfolio Balance Approaches to External Balance

Question 1

Explain the implication for a country’s exchange rate in the monetary approach and in the portfolio balance approach of (a) an autonomous decline in the demand for money at each interest rate by the country’s citizens, and (b) a change in expectations by the country’s citizens such that less inflation is expected in the future.

Answer 1

NOT ANSWER

Question 2

If M_s is the money supply, BR = reserves of commercial banks (depository institutions), C = currency held by the nonbank public, and a = the money multiplier, then

A) M_s = aBR + C
B) M_s = a(BR + C)
C) BR = M_s - C
D) aC = M_s - BR

Answer 2

B

Question 3

In the monetary approach to the exchange rate, which one of the following will cause a depreciation of A's currency relative to B's currency?

A) an increase in the amount of money demanded at each income level in country B
B) an increase in the money supply in country B
C) a fall in real income in country B
D) a decrease in the money supply in country A

Answer 3

A

Question 4

Describe a scenario that will make the current three-months forward rate on a foreign currency equal to the expected spot rate in three months for that currency. What might prevent this result from occurring?

Question 5

Why do the monetary approach and the portfolio balance approach have different expected signs for the impact of a change in the domestic interest rate on the exchange rate? Explain carefully.

Question 6

In considering the demand for money in the monetary approach to the balance of payments, it can be said that the money demand would increase if home real income
__________ and if the home interest rate __________.

A) decreases; also decreases
B) decreases; increases
C) increases; decreases
D) increases; also increases

Question 7

In the monetary approach to the balance of payments, under flexible exchange rates, an
Increase in the proportion of income that people in country A wish to hold as money
Would, other things equal, lead to an __________ in country A's balance of payments and
Therefore to __________ of A's currency in the foreign exchange markets.

A) incipient surplus; a depreciation
B) incipient surplus; an appreciation
C) incipient deficit; a depreciation
D) incipient deficit; an appreciation

Question 8

In the monetary approach to the exchange rate, a decrease in income in country I
Will, other things equal, lead to an __________ money in country I and therefore to
__________ of country I's currency against other currencies.

A) excess supply of; a depreciation
B) excess supply of; an appreciation
C) excess demand for; a depreciation
D) excess demand for; an appreciation

Question 9

Which one of the following, other things equal, would NOT cause an increase in the Amount of money demanded in country A?

A) an increase in A's national income
B) an increase in the price level in country A
C) a fall in interest rates in country A
D) an increase in the rate of expected inflation in A

Question 10

If i_d is the domestic interest rate, i_f is the foreign interest rate, xa is the expected rate of appreciation of the foreign currency (or the expected rate of depreciation of the home currency), and financial capital is mobile across countries (and assuming no risk premium), then equilibrium in international financial asset markets is indicated by the expression

A) xa = (i_d/i_f).
B) xa = i_d + i_f.
C) i_f = i_d + xa.
D) i_d = i_f + xa

Question 11

In the Dornbusch "overshooting" model, asset markets adjust __________ rapidly to disturbances than do goods markets, and therefore the exchange rate and the price level
__________ proportionately to each other in the short run.

A) more; move
B) more; do not move
C) less; move
D) less; do not move

Question 12

In the monetary approach to the balance of payments and the exchange rate,

A) an increase in the demand for money (with a fixed supply) would cause a balance-of-Payments deficit under fixed exchange rates.
B) an increase in the supply of money (with a fixed demand) would cause a balance- Of-payments surplus under fixed exchange rates.
C) a decrease in the demand for money (with a fixed supply) would cause a balance-of- Payments deficit under fixed exchange rates.
D) an increase in the supply of money (with a fixed demand) would cause the domestic Currency to appreciate under flexible exchange rates.

Question 13

in the expected rate of depreciation of the home currency)
12. The term xa in the textbook is defined as the expected rate of appreciation of the foreign currency. A mathematical way to express this definition [where e is the spot rate of the foreign currency and E(e) is the expected future spot rate of the foreign currency] is __________.

A) E(e) - e
B)
$\frac { e } { E ( e ) }$
C)
$\frac { E ( e ) - 1 } { e }$
D)
$\frac { E ( e ) - e } { e - 1 }$

Question 14

(a) Could there be "overshooting" of the exchange rate in the Dornbusch model if goods markets adjusted as rapidly as asset markets? Why or why not?

Question 15

In the monetary approach to the balance of payments and the exchange rate, if there is an excess demand for money, the result is a balance-of-payments __________ in a fixed exchange rate situation and __________ of the country's currency in a flexible exchange Rate situation.

A) surplus; an appreciation
B) surplus; a depreciation
C) deficit; an appreciation
D) deficit; a depreciation

Question 16

In the portfolio balance model, other things equal, the issuance of new bonds by a home corporation will __________ the domestic interest rate and, especially if home and Foreign bonds are very good substitutes for each other, will lead to __________ of the Home currency.

A) decrease; a depreciation
B) decrease; an appreciation
C) increase; a depreciation
D) increase; an appreciation

Question 17

In the asset market or portfolio balance approach, other things equal, a depreciation of the home currency would be caused by __________ in inflationary expectations in the home country and by __________ in real income in the home country.

A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease

Question 18

In the portfolio balance approach, which one of the following, other things equal, will cause an increase in the demand for domestic bonds by home country citizens?

A) a decrease in the home country interest rate
B) a increase in the home country price level
C) an increase in the home country real income level
D) a decrease in the expected rate of appreciation of the foreign currency (or a decrease In the expected rate of depreciation of the home currency)

Question 19

In a situation of a fixed exchange rate, explain why, in the monetary approach, an excess supply of money leads to a balance-of-payments deficit. Why is the deficit only temporary?
How might advocates of the monetary approach explain a long-lasting deficit in the balance of payments?

Question 20

Suppose that, for a country, its money supply (M^s) is at the moment equal to its demand for money (M^d). Now suppose that the country's central bank pumps new money into the economy. The result of this central bank action, other things equal, is that there will be __________ under flexible exchange rates and a consequent __________ of the country's currency.

A) an incipient balance-of-payments surplus for the country; appreciation
B) an incipient balance-of-payments surplus for the country; depreciation
C) an incipient balance-of-payments deficit for the country; appreciation
D) an incipient balance-of-payments deficit for the country; depreciation

Question 21

Because of widespread risk aversion in the financial sector in recent years, commercial banks in the United States have tended to hold __________ excess reserves than would otherwise have been the case. A result of this bank behavior is that the "money multiplier" in the U.S. economy is __________ than would otherwise have been the case.

A) a larger amount of; smaller
B) a larger amount of; larger
C) a smaller amount of; smaller
D) a smaller amount of; larger

Question 22

Under a system of flexible exchange rates, the portfolio balance approach suggests that an increase in real income in a home country will lead to __________ of that country's
Currency; under flexible rates, the monetary approach suggests that an increase in real
Income in a home country __________ of that country's currency.

A) a depreciation; will lead to an appreciation
B) a depreciation; also will lead to a depreciation
C) an appreciation; also will lead to an appreciation
D) an appreciation; will lead to a depreciation

Question 23

If e is the current spot rate (units of home currency per unit of foreign currency), e_fwd is the current three-months forward rate, E(e) is the expected spot rate in three months, and xa is the expected rate of depreciation of the home currency in three months, then, in an efficient foreign exchange market,

A) E(e) = e_fwd.
B) e = e_fwd.
C) xa = e_fwd.
D) E(e) = e.

Question 24

In the portfolio balance model, other things equal, an increase in home country wealth because of a current account surplus

A) will reduce home country demand for money.
B) will reduce home country demand for foreign bonds.
C) will have an indeterminate effect on the domestic interest rate (without more
Information).
D) will not affect the domestic demand for either foreign or domestic bonds.