Midterm_sol - Department of Economics University of California Berkeley Spring 2006 Economics 182 Suggested Answers to Spring 2006 Midterm Part I

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Department of Economics University of California, Berkeley Spring 2006 Economics 182 Suggested Answers to Spring 2006 Midterm Part I: True, False, Uncertain 1. UNCERTAIN: Remember the identity CA = S - I = S g + S p - I = ( T - G )+ S p - I . Holding private savings and investment constant, an increase in fiscal deficit will be associated with an equal increase in CA deficit. For example, a fiscal expansion under a floating exchange rate leads to a depreciation of the currency and thus is eventually reflected fully in a CA deficit. However, changes in taxes often affect private savings also (for example a lower tax rate increases the fiscal deficit, but also might lower private savings), so that the correspondence between fiscal deficit and the CA is not one-to-one. Further, consider the case of a monetary expansion where currency depreciation improves the CA deficit, but is not associated with any change in the fiscal deficit. In that case private savings rise. 2. TRUE: Uncovered interest parity states that R - R * = Δ E e . PPP states that Δ E e = π - π * . These two relations imply that R - R * = π - π * R - π = R * - π * r = r * . 3. FALSE: As Chapter 17 states, with perfect asset substitutability, sterilized foreign exchange intervention on the part of the central bank will leave the money sup- ply unchanged, which leaves interest rates, and hence, exchange rates unaffected.
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This note was uploaded on 08/01/2008 for the course ECON 182 taught by Professor Kasa during the Spring '08 term at University of California, Berkeley.

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Midterm_sol - Department of Economics University of California Berkeley Spring 2006 Economics 182 Suggested Answers to Spring 2006 Midterm Part I

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