Question

1. What is the​ short-run effect on the exchange rate of an increase in domestic real​ GNP, given expectations about future exchange​ rates?

A.Money demand​ increases, the domestic interest rate​ increases, and the domestic currency depreciates.

B.Money demand​ increases, the domestic interest rate​ increases, and the domestic currency appreciates.

C.Money demand​ decreases, the domestic interest rate​ decreases, and the domestic currency appreciates.

D.Money demand​ decreases, the domestic interest rate​ decreases, and the domestic currency depreciates.

2. In our discussion of​ short-run exchange rate​ overshooting, we assumed that real output was given. Assume instead that an increase in the money supply raises real output in the short run​ (an assumption that will be justified in Chapter​ 16). How does this affect the extent to which the exchange rate overshoots when the money supply first​ increases? Is it likely that the exchange rate​ undershoots?  

A.Since the increase in output will increase the demand for​ money, the interest rate will not fall as​ much; thus, the overshoot will be smaller. The only way for the exchange rate to undershoot is if the interest rate rises when the money supply increases.

B.Since the increase in output will increase the demand for​ money, the interest rate will decrease​ more; thus, the overshoot will be larger. The only way for the exchange rate to undershoot is if the interest rate rises when the money supply increases.

C.Since the increase in output will increase the demand for​ money, the interest rate will not increase as​ much; thus, the overshoot will be smaller. The only way for the exchange rate to undershoot is if the interest rate decreases when the money supply increases.

D.Since the increase in output will decrease the demand for​ money, the interest rate will not fall as​ much; thus, the overshoot will be smaller. The only way for the exchange rate to undershoot is if the interest rate rises when the money supply increases.

3. As we observed in the​ chapter, central​ banks, rather than purposefully setting the level of the money​ supply, usually set a target level for a​ short-term interest rate by standing ready to lend or borrow whatever money people wish to hold at that interest rate. ​ (When people need more money for some reason other than a change in the interest​ rate, the money supply therefore​ expands, and it contracts when they wish to hold​ less.)  

a.Describe the problems that might arise if a central bank sets monetary policy by holding the market interest rate constant. ​ (First, consider the​ flexible-price case, and ask yourself if you can find a unique equilibrium price level when the central bank simply gives people all the money they wish to hold at the pegged interest rate. Then consider the​ sticky-price case.)

A.If prices are​ flexible, an increase in the demand for money would require the central bank to constantly decrease the money supply to maintain the interest rate. ​ Thus, there would not be a unique solution. ​ However, if prices were​ sticky, then a unique solution could be found.

B.Regardless of whether prices are flexible or​ sticky, an increase in the demand for money would require the central bank to constantly decrease the money supply to maintain the interest rate. ​ Thus, there would not be a unique solution in either case.

C.If prices are​ flexible, an increase in the demand for money would require the central bank to constantly increase the money supply to maintain the interest rate. ​ Thus, there would not be a unique solution. ​ However, if prices were​ sticky, then a unique solution could be found.

D.Regardless of whether prices are flexible or​ sticky, an increase in the demand for money would require the central bank to constantly increase the money supply to maintain the interest rate. ​ Thus, there would not be a unique solution in either case.

Answer 1

Q1)B)

Explanation- An increase in domestic real GNP increases the demand for money at nominal interest rate.In the fig , it is shown by the outward shift in the money demand function from L1 to L2..As a result the domestic interest rate rises from R1 to R2 and appreciation of domestic currency from E1 to E2.