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16. *Suppose government officials in a small open economy decided they wanted
doesn’t take any action to offset the impact on interest rates of the foreign exchange
intervention? (LO4)
Answer: The government officials would have to sell domestic currency in exchange
17. Suppose the interest rate on a one-year U.S. bond is 10 percent and the interest
depreciate relative to the Canadian dollar over the next year? Explain your choice.
(LO3)
Answer: You would expect the U.S. dollar to depreciate. If the interest parity
rate to equate the two returns.
19. Most countries do not attempt to manage their exchange rates with intervention in the
intervention likely to be ineffective? (LO4)
Answer: First, the intervention may fail if the government lacks sufficient resources
to maintain the intended exchange rate. For example, it may need a large quantity of
bank must be willing to allow interest rates to adjust consistently with the exchange
rate objective.
20. Suppose you see the following newspaper headline: “Japan’s Finance Ministry Sells
What will happen to the prices of U.S. goods purchased by residents of Japan? (LO4)
Answer: The policy intervention by the Ministry aims to lower the value of the yen
Japan's central bank would have to be willing to lower its policy interest rate
(otherwise, the central bank would reverse the Ministry's market intervention). A
of Japan.
21. Immediately following the June 2016 U.K. referendum vote to leave the European
have contributed to this decline by shifting the demand curve for British pounds.
Illustrate the shift graphically. (LO3)
Answer: Two factors that may have shifted the demand curve for British pounds
measured by the amount of foreign currency that one must give up to acquire a
British pound.
22. The U.K. referendum vote described in Problem 21 also affected currencies other
What currency policy tool might Japan’s Ministry of Finance utilize to counter
these effects? Is it likely to be effective? (LO4)
Answer: A rising yen would hurt the competitiveness of Japanese exports and
policy intervention is unlikely to be effective without the support of a monetary
policy easing by the Bank of Japan
Data Exploration
1. Exchange rates can experience sudden changes as well as long-run patterns.
a. Plot the daily U.S. dollar-British pound exchange rate (FRED code: DEXUSUK)
(LO1)
b. Plot since 1971 the monthly Japanese yen-U.S. dollar exchange rate (FRED code:
plotted exchange rate falls?
Answer:
a. The plot for the U.S. dollar-British pound is below. The spike at the end of June,
an appreciation of the U.S. dollar.
b. The plot for the Japanese yen-U.S. dollar exchange rate is below. Periods of
sudden changes include the sharp downward movement in 1973 and again in 1985
took nearly 360 yen to buy one U.S. dollar; recently, it took less than 100 yen to
buy one U.S. dollar.
Note: In part (a), downward movement represents a U.S. dollar appreciation; in (b)
which currency is in the numerator of the exchange rate.
2. Plot since 1999, without recession bars, the real exchange rate between U.S. goods
harmonized index of consumer prices for the euro area goods (FRED code:
unity since 2003? (LO1)
Answer: A plot of the data is below. Several reasons may explain the appearance that
U.S. goods are persistently cheap compared to euro-area goods. First, non-traded
Fourth, the period may not be long enough to capture the forces that establish
purchasing power parity (PPP).
Eurostat, Harmonized Index of Consumer Prices: All Items for Euro area (19 countries)©
[CP0000EZ19M086NEST], retrieved from FRED, Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/CP0000EZ19M086NEST.
3. Write in algebraic form a calculation of U.K pounds per euro that uses U.S. dollars
per U.K pound (FRED code: EXUSUK) and U.S. dollars per euro (FRED code:
exchange rate in 2016? (LO1)
Answer: To find the indicated exchange rate, pay attention to the units in the
pounds per euro. Symbolically,
$/€
$/£
=
$
€
£
$
=
£
€
The data plot is below.
Note that the British pound depreciated versus the euro in 2016. One cause was the
uncertainty about the British economic outlook both before and after the June vote to
exit the European Union.
4. Examine an episode of large-scale interventions by the Bank of Japan (BoJ) in the
yen-dollar foreign exchange market. Plot between January 2003 and January 2005 a
the chart, but scaled on the right axis. (LO5)
Answer: The data plot is below. Positive values mean that the Bank of Japan was
buying U.S. dollars (selling yen) in the foreign exchange market. The objective was
progressed.
Bank of Japan, Japan Intervention: Japanese Bank purchases of USD against JPY© [JPINTDUSDJPY], retrieved from
FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/JPINTDUSDJPY.
* indicates more difficult problems
