Question

I. Label each of the following statements true, false, or uncertain. Explain your choice carefully. A fiscal expansion, all other factors equal, tends to increase net exports. Fiscal policy has a greater effect on output in an economy with fixed exchange rates than in an economy with flexible exchange rates. Other things equal, the interest parity condition implies that the domestic currency will appreciate in response to an increase in the expected exchange rate. If financial investors expect the dollar to depreciate against the yen over the coming year, one-year interest rates will be higher in the U.S. than in Japan. a. b. c. d. e. If the Japanese interest rate is equal to zero, foreigners will not want to hold Japanese f. Under fixed exchange rates, the money supply must be constant

Answer 1

Answer for I (a):

As per the given data & information

The correct option is “False”

Explanation:-

During a fiscal expansion, the price of a country's currency appreciates relative the rest of the world. This increases the change rate, making its goods more expensive. The increase in the price of a country's goods lowers the number of goods purchased by the rest of the world, thus decreasing its net exports.

Answer for I (b):

As per the given data & information

The correct option is “True”

Explanation:-

Fiscal policy under fixed exchanges rates than it is under flexible exchange rates. This occurs because monetary policy does not accommodate the increases caused by fiscal policy. That is, expansionary fiscal policy under fixed exchange rates does not lead to an increase in the interest rate and appreciation of currency. This does occur under flexible exchange rates, however, and it limits the effectiveness of fiscal policy

Answer for I (c):

As per the given data & information

The correct option is “True”

Explanation:-

All other things equal, an increase in the expected exchange rate will lead to an appreciation of domestic currency. Specifically, the interest parity condition implies that and increase in the expected exchange rate leads to an increase in the current exchange rate. An increase in the current exchange rate will lead to an increase in the domestic interest rate. This leads to an appreciation of domestic currency.

Answer for I (d):

As per the given data & information

The correct option is “False”

Explanation:-

If the dollar depreciates relative to the yen, one year interest rates will be higher in Japan. The interest parity relation implies that a decrease in the exchange rate, which is the depreciation of the dollar in this problem, will lead to a decrease in the domestic interest rate. Thus, the dollar will have a lower interest rate compared to the yen.

Answer for I (e):

As per the given data & information

The correct option is “Uncertain”

Explanation:-

Whether or not foreigner will want to hold Japanese bonds depends on how these bonds perform relative to other bonds. If other government bonds are performing at a higher rate, even only 1%, then foreigners will not want to hold Japanese bonds. But if domestic bonds have an interest rate equal to zero, then foreigners will be indifferent between holding Japanese bonds or domestic bonds, as neither gives them any return.

Answer for I (f):

As per the given data & information

The correct option is “False”

Explanation:-

Under fixed exchange rates the central bank cannot leave the money stock unchanged. If the money stock were not changed, then the interest rate would either increase or decrease relative to the foreign interest rate. In fact, under fixed exchange rates the central bank must constantly change the money stock to keep the domestic interest rate the same as the foreign interest rate and maintain equilibrium.

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