978-0133780581 Chapter 19 Solution Manual

CHAPTER 19

Quick Check

1. a. False. Interest rate parity means exchange rates will adjust to equate returns in countries.

g. False. Fiscal expansion increases domestic output and creates a larger trade deficit.

h. Uncertain. It depends on the policy response of the central bank under flexible exchange

i. True (up to a possible risk premium)

2. The appropriate mix is a cut in interest rates (shift the LM curve down) to lessen the value of the

3. a. Consumption increases because output increases. Investment increases because output

b. A monetary expansion has an ambiguous effect on net exports. The nominal depreciation

4. a. The IS curve shifts right, because net exports tend to increase as foreign output rises.

b. When the foreign interest rate rises, at the same domestic rate of interest, the domestic

5. a. The increase in both Y* and i* shifts the IS curve to the right. At the same domestic

114

b. If the domestic central bank matches the increase in foreign interest rates then although

c. The required domestic monetary policy change will depend on the effect on domestic

Dig Deeper

6. a. The follower country must immediately raise interest rates to match the increase in

b. The movement up the IS curve reduces output by reducing investment.

c. The follower country could use fiscal policy to shift the IS curve out and increase output

d. The fiscal policy that leaves consumption unchanged would have to leave output at the

7. a. The IS curve shifts to the left. Output falls. Investment falls – both due to the fall in

b. The LM curve will shift down. You will move down the new IS curve. The fall in interest

115

c. There are not many policy options for the central bank. Fixing your exchange rate is

d. The central bank under a flexible exchange rate has to option to set the domestic interest

Explore Further

8. a. Et=Ee

t+1(1+it+x)/(1+i*t+1)

b. The IS curve slopes down as before, but with the result in part (a) substituted for the

c. The IS curve shifts right, because the fall in the expected exchange rate creates a

d. An increase in x tends to increase the value of the domestic currency and therefore to

e. Yes and yes.

9. a-b. Answers to this question could vary substantially depending upon movements of the

c. The only country-pair with a large nominal interest rate gap over the 10 years is the

116