978-1259663048 Chapter 35 Solutions Manual

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CHAPTER 35: INTERNATIONAL FINANCIAL POLICY

Questions and Exercises

1. If a country is running a balance of trade deficit, the amount of goods it is

exporting is less than the amount of goods it is importing. This is only one part of

2. When someone sends 100 British pounds to a friend in the United States, the

transaction will show up as a positive value in the component of the current

3. In the short run, a current account deficit, necessarily balanced by a financial and

4. In the long run, financial and capital account deficits, necessarily offset by

5. a. Current account

e. Capital and financial account

6. a. Supplier

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7. They will sell that currency. If the country wants to keep the value of its currency

8. a. A rise in the UK price level causes foreign goods to become cheaper. British

demand for foreign currencies will tend to increase, and foreign demand for

b. A reduction in U.S. tariffs would tend to shift the demand for pounds to the right

(a) (b)

c. A boom in the UK economy means an increase in its income, causing an

increased demand for imports and an increase in the demand for the foreign

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d. If interest rates in the UK rise, there will be an increased demand for its assets, so

9. a. This is an enormous change. In order to bring

it about, the Never-Never government would

have to run an enormously expansionary

b. Holders of neverbacks will demand foreign currencies (increase in supply of

neverbacks) since the return on neverback assets has declined (interest rates have

fallen). This is shown as a rightward shift in the supply of neverbacks. Likewise,

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10. The schematics are shown in the text.

11. The U.S. trade deficit would fall and the value of the U.S. dollar would rise.

Japanese expansionary monetary policy leads to higher income and prices in

12. Japan’s contractionary fiscal policy would have an ambiguous effect on the value

of the U.S. dollar because the effect via the interest rate and income paths oppose

13. The effect of expansionary fiscal policy on the exchange rate is ambiguous, while

contractionary monetary policy increases exchange rates. The net effect will

14. If a country’s actual exchange rate is 20 and purchasing power parity says it is 25,

15. When a foreign country’s purchasing power parity exchange rate is less than the

16. The real exchange rate remains constant since the change in the price level offsets

17. Forcing governments to make adjustments to meet their international problems is

18. Both fixed and flexible exchange rate systems have advantages and

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19. a. If foreigners start believing that there is an increased risk of default, they will

require a higher premium to buy U.S. bonds. That is, they will offer a lower price

b. Higher interest rates increase the cost of borrowing. This hurts in the short run by

reducing aggregate spending and crowding out private investment, a source of

long-term growth for the U.S. economy. A lower value of the dollar may increase

20. The United States would want to hold up the value of the dollar to help prevent

the surge in import prices that would result from the fall in exchange rates, and to

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21. a. This suggests that it was running a financial and

capital account deficit since the two largely

b. If the private balance of payments was in

c. It had to be selling its currency to equalize the

d. The value of the yuan would likely rise. That is,

22. Four advantages are that it: (1) eliminates the cost of exchanging currencies, (2)

23. Three disadvantages of a common currency are: (1) loss of national identity, (2)

Questions from Alternative Perspectives

1. Austrian

a. Having all currencies on a gold standard would eliminate currency risk and

b. The cost of such a policy would be limiting countries’ ability to conduct domestic

2. Religious

a. Jesus would argue for an exchange rate that valued earthly things low and eternal

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D e m a n d

b. I would suspect that wealthy people would value earthly things higher relative to

c. I suspect that the perceived value of earthly things fall as one gets older. (The

3. Feminist

a. There is no good reason. It is probably historical happenstance rooted in sexism or

b. One reason it has remained that way is that the traders are self-perpetuating; they

c. Yes, one of the reasons trading rooms have remained primarily male is that the

d. This answer will be individual specific.

4. Post-Keynesian

His argument is that the pressures for change are so strong, once people start

expecting a major change in the price of a currency, a small tax will not stop them

from buying in a financial crisis. The tax would slow capital flows in normal times

when there is no need to slow them, and not stop capital flows in crises when there is

a need to slow them.

5. Radical

a. This is a judgment question and judgments differ. Radical economists are especially

b. This, too, is a judgment question and judgments differ. As stated above in a, radical

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Issues to Ponder

1. In the early 1980s the U.S. government was pursuing tight monetary policy and

expansionary fiscal policy. The high interest rate resulted in a strong dollar.

2. He was advocating significant trade restrictions. These trade restrictions would

3. No. It is extremely difficult to affect exchange rates. Since we don’t know what

4. We would use a combination of purchasing power parity, current exchange rates,

and estimates by foreign exchange traders to determine the long-run exchange

5. He will more likely prefer fixed exchange rates. They provide an anchor, which

6. a. Three assumptions of the law of one price are: (1) there are zero transportation

b. For the law of one price to apply directly, labor would have to be completely

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c. Since capital is more mobile than labor, we would expect that the law of one price

7. A common currency would tie these countries together much more closely, create

a larger common market, and make price comparisons among Canada, the United

8. A rising price level would replace the income effect usually associated with

9. Holding the exchange rate above the equilibrium market exchange rate will make

a country’s exports more expensive and its imports cheaper than they otherwise

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