Question 1

Under a fixed exchange rate regime, if there is a 40% chance a 40% devaluation will occur in a months time, the financial markets will hold domestic bonds only if the central banks set:

A. an annual interest rate 192% higher than before.

B. an annual interest rate 40% lower than before.

C. a monthly interest rate 16.00 % lower than before.

D. a monthly interest rate 40 % higher than before.

In a fixed exchange rate regime, expectations that a devaluation may be coming can trigger an exchange rate crisis which the government may address by allowing a devaluation or trying to maintain the parity through interest rate changes. The problem with the second option is:

A. a decrease to savings.

B. an increased risk of inflation.

C. an increased risk of recession.

D. an increase in consumption.

Question 2

In an open economy, you must differentiate between the demand for domestic goods and the domestic demand for goods by:

A. adding the quantity of imports.

B. subtracting the quantity of imports.

C. subtracting the value of imports in terms of domestic goods.

D. subtracting the part of the demand for domestic goods that comes from abroad.

In an open economy where C = 2,475, I = 250, G = 525, X = 225, and IM = 225, and the real exchange rate () = 0.90 the values of which are expressed in terms of domestic goods, the domestic demand for goods is_______ and the demand for domestic goods is_________. (Provide response as a whole number.)

Please provide answers with brief explanation why answers were selected.