1. In the short run, with prices fixed, how would a decrease in the foreign nomi
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Question
1. In the short run, with prices fixed, how would a decrease in the foreign nominal money supply affect the exchange rate and output according to the DD-AA schedule?
A. It would increase home output and appreciate the home currency
B. It would decrease home output and appreciate the home currency
C. It would increase home output and depreciate the home currency.
2. Imagine that the economy is at a point on the DD-AA schedule that is below the AA curve and to the right of the DD curve, suggesting that both the output and asset markets are out of equilibrium. Which of the following best derbies the immediate response to these disequilibria?
A. At the current exchange rate, there is an excess supply of output. Producers will cut production until aggregate demand equals supply
B. The domestic currency is overvalued at the current level of output. The exchange rate will rise until asset market equilibrium is restored.
C. The domestic currency is undervalued at the current level of output. The exchange rate will fall until asset market equilibrium is restored.
3. Honduras runs a fixed exchange rate with the US. Suppose that the Honduran. Central bank wanted to devalue their currency (the lempira), but leave the Honduran money supply unchanged. Which of the following would accomplish this goal?
A. They purchase lempira with reserves of US dollars, then sell Honduran bonds to the Honduran Public
B. They purchase dollars with lempira, then sell Honduran bonds to the Honduran public
C. They purchase dollars with lempira, then buy Honduran bonds from the Honduran public
4. If speculators believe that a fixed exchange rate is about to be revalued (i.e. increased in value against the anchor currency), then what must the central bank do to keep the exchange rate fixed?
A. Ensure that home interest rates remain equal to foreign interest rates
B. Drop home interest rates below foreign interest rates
C. Raise home interest rates above foreign interest rates above foreign interest rates to fend off the speculative attack
Explanation / Answer
1) Answer (C)-A decrease in foreign nominal money supply would appreciate the foreign (i.e. depreciate the home currency). Due to this depreciation in home currency, the home output would increase.
2) Answer (b)-The domestic currency is overvalued at the current level of output. The exchange rate will rise until asset market equilibrium is restored.
3) Answer (b)-The purchase of dollars with lempira would appreciate dollars (as the supply of dollars would reduce), then selling of Honduran bonds to the Honduran public would remove the excess Honduran currency from the market. This would lead to an overall devaluation of the Hondurian currency. In other options. Lempira would be revalued.
4) Answer (c)-Raising home interest rates above foreign rates would create demand for local currency and would , thus, help in maintaing the fixed exchange rate.
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