11. [5 pts] Challenging. Assume the U.S. and Europe are the only countries in the world. Suppose we observe the nominal interest rate in the United States fall and the dollar appreciate. Does the long-run approach (monetary approach) or the short-run approach (asset approach) better explain this phenomenon? Explain your reasoning.1. Compare the effect of capital outflows in Stand the FX Central Bank reserves under a floating exchange rate system and a fixed exchange rate system. 2. Brunei has fixed its currency, the Brunei dollar (BND), to the Singapore dollar (SGD), fixing the parity at 1. During the recent past, oil prices have decrease substantially. Brunei's economy is heavily dependent on oil. (a) Describe the pressures the BND faces due to the increase in oil prices? What does the CB of Brunei have to do in order to support the fixed FX exchange rate? Do the FX reserves increase or decrease in the BND? (b) What is the impact on Brunei's domestic money supply and interest rates? (c) How can the CB neutralize (sterilize) the effect of low oil prices on Brunei's money supply? 3. Before a national election, many governments engage in expansionary policies to stimulate the economy. Suppose that one of these countries has a fixed exchange rate system. Describe how an expansionary monetary policy can generate a currency crisis. If a government decides to keep the fixed exchange rate system and the expansionary monetary policy, what measures can the government take to delay a currency run? 4. The Banco Central de Chile (BCC) considers the USD overvalued. BCC decides to intervene, but does not want to affect local interest rates. Using graphs, describe the effect of central bank intervention on the CLP/USD exchange rate, on CLP interest rates and on Chilean money supply. (CLP: Chilean peso.)1. Assume the following information: SLUSD/AUD= .8 USD/AUD SLUSD/GBP = 1.40 USD/GBP SLAUD/GBP= 1.80 AUD/GBP Is triangular arbitrage possible? If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy (expressed as a % per unit borrowed). Explain how market forces move to eliminate triangular arbitrage's profits. 2. Difficult. Let's complicate triangular arbitrage, by introducing bid-ask spreads. Assume the following information: SLUSD/AUD= .81-.82 USD/AUD SLUSD/GBP = 1.40-1.42 USD/GBP Calculate an arbitrage-free cross rate (AUD/GBP) quote (with bid-ask spread). 3. Assume the following information: St= 1.10 USD/EUR IEUR = 1.50% iusD = 2.75% T = 180 days (A) Determine the arbitrage-free 180-day forward rate (use IRP). (B) Suppose Bank Q offers For,180 = 1.12 USD/EUR. Given this information, is covered interest arbitrage possible? Design a covered arbitrage strategy and calculate its profits. (C) Suppose Bank P offers Fliso = 1.08 USD/EUR. Given this information, is covered interest arbitrage possible? Design a covered arbitrage strategy and calculate its profits. 4. Assume the following information: SI= 1.40 USD/GBP F 1,270= 1.42 USD/GBP IGBP = 2.50% iusD = 2.75% T = 180 days Calculate p (the forward premium) and the interest rate differential. What kind of capital flows the U.K. economy will experience?8. [15 pts] Is the short-run exchange rate Egyp above or below the expected long-run exchange mate? Will it stay this way forever? Explain your answer.17. If neither investment nor consumption depends on the interest rate, then the IS curve is _ and policy has no effect on output. A) vertical; monetary horizontal; monetary vertical; fiscal horizontal; fiscal 18. An increase in investment demand for any given level of income and interest rates--due, for example, to more optimistic "animal spirits"--will, within the IS-LMframework, _ output and interest rates. A increase; lower increase; raise lower; lower lower; raise 19. An economic change that does notshift the aggregate demand curve is a change in: A) the money supply. B) the investment function. the price level. D) taxes 20. The spending hypothesis suggests that the Great Depression was caused by a: A) leftward shift in the /S curve. B) rightward shift in the /Scurve. leftward shift in the LM curve. D) rightward shift in the LM curve. 21. Assume that an economy is described by the /Scurve Y = 3,600 + 3G - 27 - 150r and the LMcurve Y =2 /WP+ 100rfor r= 0.01 Y- 0.02(M/P)]. The investment function for this economy is 1,000 - 50r. The consumption function is C = 200 + (2/3)(Y - T). Long-run equilibrium output for this economy is 4,000. The price level is 1.0 and M= 1,200. a. Assume that government spending is fixed at 1,200. The government wants to achieve a level of investment equal to 900 and also achieve Y= 4,000. What level of ris needed for /= 900? What levels of Tand Mmust be set to achieve the two goals? What will be the levels of private saving, public saving, and national saving? (Hint: Check C+ /+ G = Y.) b. Now assume that the government wants to cut taxes to 1,000. With G set at 1,200, what will the hterest rate be at Y= 4,000? What must be the value of M? What will / be? What will be the levels of private, public, and national saving? (Hint. Check C + / + G = Y.) c. Which set of policies may be referred to as tight fiscal, loose money? Which set of policies may be referred to as loose fiscal, tight money? Which "policy mix" most encourages investment? 22. If consumption is given by C = 200 + 0.75( Y - 7) and investment is given by /= 200 - 25/, then the formula for the /Scurve in a closed economy is: A) Y= 400 - 0.757 - 25r+ G. B) Y= 1,600 - 37- 100r+ 4G. C) Y= 400 + 0.757 - 25r - G. D) Y= 1,600 + 37- 100r- 4G. 23. Other things equal, a given change in money supply has a larger effect on demand the: A) flatter the /S curve. B) steeper the /Scurve. smaller the interest sensitivity of expenditure demand. smaller the income sensitivity of expenditure demand. Page 3 24. Suppose Congress wishes to reduce the budget deficit by reducing government spending. Use the IS- LM model to illustrate graphically the impact of the reduction in government spending on output and interest rates. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values 25. The monetary transmission mechanism in the /S-LMmodel is a process whereby an increase in the money supply increases the demand for goods and services: Al directly. B) by lowering the interest rate so that investment spending increases. by raising the interest rate so that investment spending increases. D) by increasing government spending on goods and services. 26. One policy response to the U.S. economic slowdown of 2001 was a tax cut. This policy response can be represented in the /S-LMmodel by shifting the _ curve to the A) LM, right B) LM, left C) IS; right IS; left 27. A given increase in taxes shifts the /S curve more to the left the: A) larger the marginal propensity to consume smaller the marginal propensity to consume. larger the government spending. smaller the government spending.1. 5 pts] Assume that prices are perfectly flexible. The money supply in England ( 2) is expected to grow at 3% percent per year and the money supply in Canada (CAD) is expected to grow at 7%% per year. Each country's real output growth rate is expected to be 2%. What is deD,, the expected CAD-pound depreciation rate?2. (5 pts] If the Japanese interest rate is 0.5%, the U.S. interest rate is 2.5% and the expected dollar-ven exchange rate is E= 0.01, what theory could you use to find the spot dollar-yen exchange rate? What is the value of the spot exchange rate according to the theory