Solution
1. How would the following transactions be categorized in the U.S. balance of payments
accounts? Would they be entered in the current account (as a payment to or from a
foreigner) or the financial account (as a sale of assets to or purchase of assets from a for–
eigner)? How will the balance of payments on the current and financial accounts change?
1. a. When the French importer buys the California wine, the transaction is entered as
a payment from foreigners in the current account. The balance of payments on the
U.S. current account will rise.
2. The accompanying diagram shows foreign-owned assets in the United States and U.S.-
owned assets abroad, both as a percentage of foreign GDP. As you can see from the
diagram, both increased around fivefold from 1980 to 2013.
Percent of
rest-of-the-world
GDP
Open-Economy Macroeconomics 19
CHAPTER
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S-238 CHAPTER 19 OPEN-ECONOMY MACROECONOMICS
a. As U.S.-owned assets abroad increased as a percentage of foreign GDP, does this
mean that the United States, over the period, experienced net capital outflows?
b. Does this diagram indicate that world economies were more tightly linked in 2013
than they were in 1980?
2. a. No, the diagram does not indicate that the United States experienced net capital
financial crisis in another country.
3. In the economy of Scottopia in 2014, exports equaled $400 billion of goods and $300
billion of services, imports equaled $500 billion of goods and $350 billion of services,
3. In 2014, the merchandise trade balance was −$100 billion ($400 billion − $500 bil-
lion). The balance of payments on current account was −$150 billion [($400 billion
4. In the economy of Popania in 2014, total Popanian purchases of assets in the rest of
4. In 2014, Popania’s balance of payments on financial account was +$100 billion ($400
billion − $300 billion). Since the balance of payments on financial account plus the
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5. Suppose that Northlandia and Southlandia are the only two trading countries in the
world, that each nation runs a balance of payments on both current and financial
accounts equal to zero, and that each nation sees the other’s assets as identical to its
own. Using the accompanying diagrams, explain how the demand and supply of loan-
able funds, the interest rate, and the balance of payments on current and financial
accounts will change in each country if international capital flows are possible.
12%
10
8
6
Interest
rate
(a) Northlandia
S
5. Since the interest rate is 10% in Northlandia and 6% in Southlandia, demanders
of loanable funds in Northlandia will want to borrow in Southlandia and suppliers of
loanable funds in Southlandia will want to lend in Northlandia. As the supply
of loanable funds falls in Southlandia, the interest rate in Southlandia will rise; as the
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Northlandia equal to 250. So the two countries will both end up with an interest rate
of 8%. Northlandia will run a surplus of 250 in the financial account and a deficit
of 250 in the current account; Southlandia will run a deficit of 250 in the financial
account and a surplus of 250 in the current account.
6. Based on the exchange rates for the first trading days of 2013 and 2014 shown in the
accompanying table, did the U.S. dollar appreciate or depreciate during 2014? Did the
movement in the value of the U.S. dollar make American goods and services more or
less attractive to foreigners?
October 1, 2013 October 1, 2014
US$1.62 to buy 1 British pound sterling US$1.62 to buy 1 British pound sterling
29.51 Taiwan dollars to buy US$1 30.43 Taiwan dollars to buy US$1
6. The U.S. dollar appreciated against the Taiwanese dollar, Canadian dollar, Japanese
yen, the euro, and the Swiss franc. And it stayed the same against the British pound.
7. Go to http://fx.sauder.ubc.ca. Using the table labeled “The Most Recent Cross-Rates
of Major Currencies,” determine whether the British pound (GBP), the Canadian dol-
7. Answers will vary. On December 3, 2014, the exchange was US$1.57 per British
pound, $1.23 per euro, $0.88 per Canadian dollar, 119.82 Japanese yen per U.S.
S-240 CHAPTER 19 OPEN-ECONOMY MACROECONOMICS
12%
10
Interest
rate
(a) Northlandia (b) Southlandia
S
12%
10
Interest
rate
S
Excess supply
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Solution
8. From January 1, 2001, to June 2003, the U.S. federal funds rate decreased from 6.5%
to 1%. During the same period, the marginal lending facility rate at the European
Central Bank decreased from 5.75% to 3%.
a. Considering the change in interest rates over the period and using the loanable
€1.4
1.2
1.0
0.8
Exchange rate
(euros per
U.S. dollar)
8. a. The federal funds rate and the marginal lending facility rate suggest that inter-
est rates in the United States went from being higher than European rates at the
beginning of the period to lower than European rates at the end of the period. The
9. In each of the following scenarios, suppose that the two nations are the only trading
nations in the world. Given inflation and the change in the nominal exchange rate,
which nation’s goods become more attractive?
a. Inflation is 10% in the United States and 5% in Japan; the U.S. dollar– Japanese yen
exchange rate remains the same.
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S-242 CHAPTER 19 OPEN-ECONOMY MACROECONOMICS
Solution
9. a. If inflation is 10% in the United States and 5% in Japan, and the U.S. dollar–
Japanese yen exchange rate remains the same, Japanese goods and services will be
more attractive than U.S. ones.
b. If inflation is 3% in the United States and 8% in Mexico, and the price of the U.S.
10. Starting from a position of equilibrium in the foreign exchange market under a fixed
exchange rate regime, how must a government react to an increase in the demand for
the nation’s goods and services by the rest of the world to keep the exchange rate at its
fixed value?
10. If there is an increase in the demand for that nation’s goods and services, there will
also be an increase in the demand for its currency, putting upward pressure on the
value of the currency. There are three ways in which the central bank can keep the
11. Suppose that Albernia’s central bank has fixed the value of its currency, the bern, to
the U.S. dollar (at a rate of US$1.50 to 1 bern) and is committed to that exchange
rate. Initially, the foreign exchange market for the bern is also in equilibrium, as
shown in the accompanying diagram. However, both Albernians and Americans begin
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CHAPTER 19 OPEN-ECONOMY MACROECONOMICS S-243
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11. If both Albernians and Americans begin to believe that the Albernian assets are
risky, this will reduce the demand for the bern (from D1 to D2 in the accompany-
ing diagram), as Americans become less willing to buy Albernian assets, and increase
the supply of the bern (from S1 to S2), as Albernians become more willing to buy
12. Your study partner asks you, “If central banks lose the ability to use discretionary
monetary policy under fixed exchange rates, why would nations agree to a fixed
exchange rate system?” How do you respond?
12. You would respond by explaining the advantages of a fixed exchange rate. First, it
reduces some uncertainty that might make businesses reluctant to undertake interna-
13. Suppose the United States and Japan are the only two trading countries in the world.
What will happen to the value of the U.S. dollar if the following occur, other things
equal?
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S-244 CHAPTER 19 OPEN-ECONOMY MACROECONOMICS
Solution
13. a. If Japan relaxes import restrictions, Japanese residents will demand more U.S.
goods and more U.S. dollars to buy those goods. The U.S. dollar will appreciate due
to the increase in the demand for U.S. dollars.
b. If the United States imposes import restrictions, Americans will buy fewer Japanese
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