(2 points) Mark the incorrect statement regarding the law of one price and the Purchasing Power Parity theory

The Purchasing Power Parity (PPP) is a less strict concept than the law of one price. The PPP may hold even if the law of one price does not hold for all products. However, when the law of one price holds, the PPP also holds.

One reason why relative PPP fits better the data than absolute PPP is due to differences in the representative basket of commodities used to calculate CPIs across countries.

The relative PPP theory suggests that fluctuations in the nominal exchange rate (measured as Local currency ) are equal to the difference between the inflation of the foreign economy and

the inflation of the domestic economy.

The PPP theory states that the nominal exchange rates between two countries measured

as Local currency is equal to the relative price of the composite good representative of the Foreign currency

domestic economy in terms of the composite good that represents the foreign economy.

(2 points) Mark the correct statement about the Monetary Approach to the Exchange Rate.

Since the Monetary Approach to the exchange rate assumes that prices are flexible, this theory can work both in the short and long run.

One prediction of the Monetary Approach to the exchange rate is that when the growth rate of the money supply increases permanently, the depreciation rate of the domestic currency does not increase in the long run.

One of the predictions of the Monetary Approach to the exchange rate is that a permanent increase in the money supply of the foreign economy leads to a long-run appreciation of the domestic currency with respect to the foreign currency.

All are correct

(2 points) Mark the incorrect statement about the Real Exchange Rate Approach to the Exchange Rate.

WhiletheMonetaryApproachconsidersthatnominalexchangeratesdependonlyonfluctuations in the money supply, the Exchange Rate Approach also includes fluctuations in the "real" side of the economy as a determinant of the nominal exchange rate.

A change in world customers' preferences towards demanding more foreign goods relative to domestic goods causes a real exchange rate depreciation (Hint: Base your answer on the RS-RD diagram studied in class)

The real exchange rate is approximated as the ratio between foreign prices and domestic prices, multiplied by the nominal exchange rate (q = E P )

P

An increase in the productivity of domestic workers depreciates the real exchange rate.

(2 points) Regarding both of the theories about the long-run determination of the Nominal Exchange

rate, which of the following statements is more likely to be true?

At equilibrium, fluctuations in real exchange rates must be compensated by a differential between real interest rates according to the Real Exchange Approach to exchange rates.

The Monetary Approach to Exchange Rates incorporates nominal frictions to analyze exchange rate determination.

It is easier to fit short-term fluctuations of nominal exchange rates with the Monetary Approach to Exchange rates rather than the Real Exchange rate. Approach to Exchange rates.

Foreign currency

1

All of them are true

(2 points) Regarding the DD, which of the following statements is false?

An increase in nominal prices, shifts the DD to the left.

If State governments increase the sales taxes to reduce fiscal deficit, the DD shifts to the left.

The DD is defined as all combinations of real exchange rates and output such that the real market is at equilibrium.

An increase in the nominal exchange rate increases the current account. Therefore, the DD moves to the right.

(2 points) Regarding the AA, which of the following statements is true?

An increase in the expected exchange rate reduces the demand for foreign assets, increasing the demand for domestic bonds and moving the AA curve to the right.

The AA collects all combinations of output and real exchange rate such that both the forex and money markets are at equilibrium simultaneously.

A temporary increase in the money supply of the foreign economy shifts the AA to the left.

All statements are true

(2 points) Which of the following statements is correct regarding the effect of a monetary policy intervention?

A permanent expansionary monetary policy shock generates an undershooting of the exchange rate

Following a permanent expansionary monetary policy shock, both the AA and DD curves move to reach the short-run equilibrium of the economy.

In the long run, a permanent contractionary monetary policy shock reduces the output level of the economy.

Consider two monetary policies, policy 1, and policy 2. Policy 1 is a temporary increase in the monetary base worth 100 US$ million, while policy 2 is a permanent increase in the monetary base by the same value of 100 US$ million. In the short run, the boost in output induced by policy 2 is greater than that of policy 1.

(2 points) Which of the following statements is correct regarding the effect of a fiscal policy intervention?

A permanent increase in government expenditure causes a crowding out between government expenditure and the current account.

A permanent increase in government expenditure has a positive short-run effect on output while causing an appreciation of the domestic currency.

A temporary decrease in government expenditure depreciates the exchange rate in the long run

All of them are correct

(2 points) Regarding the XX curve, mark the false statement

In the short run, a temporary increase in the government expenditure causes an "excess of deficit" in the current account.

The XX curve has a positive slope and it is steeper than the AA curve.

The XX curve is characterized by all the combinations of output and nominal exchange rate

such that the current account remains at a desirable level X

In the short run, a temporary increase in the money supply causes an "excess of surplus" in the current account.