sp05final_sol

sp05final_sol - Department of Economics University of...

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Department of Economics Spring 2005 University of California, Berkeley Economics 182 Suggested Solutions to the Final Part I. Definitions 1. A financial account credit is any borrowing from foreigners or, in other words, selling of assets to foreigners (“exports” of assets). These transactions enter the financial account as a credit (hence, with a positive sign) because they represent a financial inflow (sometimes also called a capital inflow) to the country that is borrowing. 2. The referred trilemma basically states that, of the three policy goals that most open economies have – independence in monetary policy, stability in the exchange rate, and the free movement of capital -, only two can be reached simultaneously. 3. The Fischer effect states that, all else equal, a rise in a country’s expected inflation rate will eventually cause an equal rise in the interest rate that deposits of its currency offer. Similarly, a fall in the expected inflation rate will eventually cause a fall in the interest rate. 4. The economic stability loss from joining a currency area is the cost that arises from joining the currency area. By joining, the country gives up its ability to use exchange rate and monetary policy for the purpose of stabilizing domestic output and employment. These costs are smaller the more economically integrated the country is with its exchange rate partners. 5. This theory basically states that world income distribution can be explained by the quality of the institutions of each country. In particular, it emphasizes that countries that are prosperous today are those in which settlers implemented European-type institutions. 6. The theory of PPP states that the exchange rate between two countries’ currencies equals the ratio of the countries’ price levels. It therefore predicts that a fall (rise) in a currency’s domestic purchasing power (that is, and increase in the domestic price level) will be associated with a proportional depreciation (appreciation) of the exchange rate. Part 2. Short Questions
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sp05final_sol - Department of Economics University of...

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