182midtermsol

182midtermsol - Department of Economics University of...

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Department of Economics Spring 2005 University of California, Berkeley Economics 182 Suggested Solutions to the Midterm Part I . 1. FALSE. An expansionary fiscal policy can affect output under a floating exchange rate if the expansion is expected to be temporary . In this case, the DD schedule shifts to the right and, since expected exchange rate is not affected, the AA schedule does not shift at all. 2 . FALSE. As Chapter 17 states, with perfect asset substitutability, sterilized foreign exchange intervention on the part of the central bank will leave the money supply unchanged, which leaves interest rates, and hence, exchange rates unaffected. With imperfect asset substitutability, sterilized foreign exchange intervention can affect the exchange rate, while leaving the money supply and interest rates unchanged. Suppose that, as in the case of imperfectly substitutable assets, the central bank sells some of its foreign reserves, but makes a corresponding purchase of domestic assets, such as government debt. This leaves the money supply and interest rates unchanged. You should recall that it is the investing public from whom the central bank purchases domestic assets. Because, as the model in Chapter 17 has it, the stock of the public’s holdings of domestic government debt has fallen, the riskiness of the public’s collective portfolio of government debt has declined. This shifts the expected return curve downward, leading to an appreciation of the currency, even when the money supply has not changed. 3. FALSE. The Balassa-Samuelson theory is based on the idea that countries with greater productivity in traded-goods sectors should, other things equal, have higher price levels. Nontradables are assumed to have roughly the same productivity in any country (think of a haircut). If prices of traded-goods are nearly the same in all countries, higher productivity in tradables industries in rich countries implies higher wages, higher production costs, and therefore higher nontradables prices and higher price levels. 4. TRUE. The Balance-of-Payments identity states that the sum of the current account,
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182midtermsol - Department of Economics University of...

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