Suggested answers to case study discussion questions
Why Are U.S. Trade Deficits So Big?: First, if U.S. private saving decreases, then the United
States will need additional financial capital inflows to fund the government budget deficit and
domestic real private investment. With increased financial capital inflows, the trade deficit tends
to increase. (In a floating rate system, the country achieves external balance. If the financial
Can Governments Manage the Float?:Here is some additional background. The tsunami killed
more than 15,000 people and caused hundreds of billions of dollars of property damage. The
Japanese economy was weakened, with real GDP declining as production was severely
disrupted. Yet, the exchange rate value of the Japanese yen increased in the week after the
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Suggested answers to end of chapter questions and problems
1. Agree. The change in the exchange rate that occurs when there is a
change in monetary policy is the basis for the enhanced eectiveness
of monetary policy under oating exchange rates. For instance, when
monetary policy shifts to be more expansionary, the decrease in the
2. The increase in government spending affects both the current account and the financial
account of the country’s balance of payments. The increase in government spending
increases aggregate demand, production, and income. The increase in income and
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3. Disagree. Under oating exchange rates the decrease in our exports
reduces demand for our currency in the foreign exchange market, so
our currency depreciates. The depreciation improves our international
price competitiveness, so exports tend to rebound somewhat, and
4. The decrease in demand for money tends to reduce domestic interest rates. The lower
domestic interest rates encourage borrowing and spending, so domestic product and
income increase because of the increase in domestic expenditure. The country’s current
account tends to deteriorate because the increase in domestic product and income
5. The tendency for the overall international payments to go into de-cit
puts downward pressure on the exchange-rate value of the country’s
currency, and it depreciates. This moves the country further from
6. a. The contractionary monetary policy increases domestic interest rates, so borrowing and
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
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b. The increase in British interest rates draws a capital inflow, so Britain’s financial account
tends to improve. The decrease in British product and income reduces imports, so
c. As the pound appreciates, Britain tends to lose international price competitiveness
(assuming overshooting—the currency appreciation occurs more quickly than the decline
7. a. The increase in taxes reduces disposable income and reduces
aggregate demand. U.S. domestic product and income will fall (or be
lower than they otherwise would be). If national income is lower,
spending on imports will be lower, so the U.S. current account will
b. The pressures on the exchange-rate value of the dollar depend on which
change is larger: the improvement in the current account or the
c. If the dollar depreciates, then the United States gains international
price competitiveness. U.S. exports increase and imports decrease. The
8. The increase in the foreign money supplies tends to lower foreign interest rates. The
lower foreign interest rates spur borrowing and spending in foreign countries. The
increase in foreign product and income increases the demand for imports, so our exports
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
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9. a. The FE curve shifts to the right or down.
b. The country’s international payments tend toward surplus. The extra
c. The appreciation reduces the country’s international price
competitiveness, so the country’s exports decrease and its imports
increase. The current account worsens, reducing the overall surplus. In
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
10. a. The increase in foreign demand for the country’s exports shifts the IS curve to the right to
IS’ in the accompanying graph. The shock increases demand for the country’s products, so
b. The rightward shift of the IS curve results in a new IS’-LM intersection with some
increase in the level of domestic product. The increase in domestic product and income
also increases the country’s imports. To proceed, let’s examine the “normal” case in which
c. The currency appreciation reduces the country’s international price competitiveness, and
the country’s net exports decrease. As the reduction in net exports reduces demand for the
country’s domestic product, the IS’ curve shifts back toward the original IS curve. As the
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forwarded, distributed, or posted on a website, in whole or part.
11. a. The central bank probably made a pro-t. The central bank bought pesos
at $3.00/peso, sold pesos at $3.50/peso, bought pesos at $3.10/peso,
and sold pesos at $3.40/peso. The central bank bought pesos low and
b. The central bank probably made a pro-t. The central bank sold yen at
$0.60/yen, $0.55/yen, and $0.51/yen. Then, with the exchange rate
value stabilized, the central bank could, if it wanted to, buy yen to
12. In this situation there is a case for international macroeconomic policy coordination. Each
country is trying to gain international price competitiveness by using expansionary
monetary policy to depreciate its currency—to lower the exchange rate value of its
currency. Each country is trying to generate more national economicgrowthby exporting
more and importing less. There are several ways in which international policy
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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.