help explain based on given marks 03. (a) How would you show your understanding
ID: 1134531 • Letter: H
Question
help explain based on given marks 03. (a) How would you show your understanding on the relation of uncovered interest (8 marks) parity? Explain (b) Suppose a country is experiencing an expansion and trade deficit. Further assume that the policy makers' goals are to achieve full employment output and trade balance. Given this information, what type of exchange rate and/or fiscal policy can be used to achieve simultaneously these two goals? Explain. (7 marks) Using the ZZ/Y and NX graphs, illustrate graphically and explain the effect of (15 marks) Total: 30 marks] (c) real depreciation on a country's trade balance and output.Explanation / Answer
And (a) - An uncovered interest parity is attempting to forecast future spot rates through the relationship between the currency interest rates and the current spot rates. The trader cannot lock in any kind of future rate, only make a projection based on their analysis. The greatest difference in these types of instrument is that the covered interest parity will have a locked in future rate. An uncovered interest parity is more of a speculation in that the trader has to attempt to project where the future rate will end up.
A visual representation of uncovered interest rate parity holding in the foreign exchange market, such that the returns from investing domestically are equal to the returns from investing abroad. When the no arbitrage condition is satisfied without the use of a forward contract to hedge against exposure to exchange rate risk, interest rate parity is said to be uncovered. Risk neutral investors will be indifferent among the available interest rate in two countries because the exchange rate between those countries is wxpexpec to adjust such that the dollar return on dollar deposit is equal to the dollar return on euro deposit, . Uncovered interest rate parity helps explain the determination of the spot exchange rate. The following eqauatie represent uncovered interest rate parity.
(1+i$)= Et( St +k) ( 1+ic). St
Where
Et(St+k) is the expected future spot exchange rate at time t+k
K is the number of periods into the future from time to time
S t is the current spot exchange rate at time t
i $ is the interest rate in one country
i c is the interest rate in another country or currency area
The dollar return on dollar deposit, 1+ i$ is shown to be equal to the dollar return on euro deposit, Et (S t+k) (1+ ic). St
Ans b)- Fiscal policy is the use of government expenditure and taxes to influence the level of econeecon activity. Discretionary fiscal policy may be either expansionary or contractionary.
A change in government purchases shift the aggregate demand curve at a given price level by an amount equal to the initial change in government purchases times the multiplier. The change in real GDP, however, will be reduced by the fact that the price level will change.
A change in income taxes or government transfer payments shift the aggregate demand curve by a multiple of the initial change in consumption that the change in income tax or transfer payments causes, then the change in a real GDP will be reduced by the fact that the price level be change.
A change in government purchases has a larger impact on the aggregate demand curve than does an equal change in income taxes or transfers. Changes in business tax rates, including an investment tax credit, can be used to influence the level of investment and thus the level of aggregate demand.
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