We indicated a sterilized intervention refers to when a countrys central bank offsets any change in its foreign asset position with an equal and opposite change in its domestic asset position.

Suppose the central bank of Japan has an inflow of US dollar denominated assets equal to $800M and it decides to sterilize this inflow. What does our 2-panel model of exchange rates suggest will happen to the value of the Japanese yen in terms of the dollar as a result of this operation? (Remark: this question requires a bit of thought on your part).

A. The yen will fall as Japanese bond prices will fall if the central bank sterilizes the inflow.

B. The yen will rise as Japanese interest rates rise if the central bank sterilizes the inflow.

C. The yen will fall as Japanese interest rates fall if the central banks sterilize the inflow.

D. The yen will not change but Japanese interest rates will rise if the central bank sterilizes the inflow.

E. The yen will not change, nor will Japanese interest rates, since the Japanese money supply does not change.

Some economies are more tightly linked than others. For example, the US has substantial trade with Canada and Mexico, and less so with various economics in Europe, parts of Asia, and Africa.

Suppose there is news of an increase in an US leading economic indicator. Because of this piece of news we might expect in the very short run that:

A. There is a smaller appreciation of the US dollar relative to the Canadian dollar than there would be between the US dollar and the euro.

B. There is a greater appreciation of the US dollar relative to the Canadian dollar than there would be between the US dollar and the euro.

C. We would expect that the appreciation of the US dollar relative to the Canadian dollar would be roughly the same as that of the US dollar and the euro.

D. The news of an increase in the US leading economic indicator will have an effect on the US dollar-Canadian dollar exchange rate, but minimal impact on the US dollar-euro rate, since the volume of US trade with Europe is smaller than that with Canada.

E. None of the above. This news would lead to a depreciation of the dollar relative to these currencies, not an appreciation.