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Unformatted text preview: Econ 356 Introduction to International Finance Spring 2010 Department of Economics, University of British Columbia Viktoria Hnatkovska Problem Set 4: Solution 1. Problem 2, Chapter 15 in KO, 8th edition. A real currency appreciation may result from an increase in the demand for nontraded goods relative to tradables which would cause an appreciation of the exchange rate since the increase in the demand for nontradables raises their price, raising the domestic price level and causing the currency to appreciate. In this case exporters are indeed hurt. Real currency appreciation may occur for di/erent reasons, however, with di/erent implications for exporters incomes. A shift in foreign demand in favor of domestic exports will both appreciate the domestic currency in real terms and bene&t exporters. Similarly, productivity growth in exports is likely to bene&t exporters while causing a real currency appreciation. If we consider a ceterus paribus increase in the real exchange rate, this is typically bad for exporters as their exports are now more expensive to foreigners which may reduce foreign export demand. In general, though, we need to know why the real exchange rate changed to interpret the impact of the change. 2. Problem 6, Chapter 15 in KO, 8th edition. A permanent shift in the real money demand function will alter the long-run equilib- rium nominal exchange rate, but not the long-run equilibrium real exchange rate. Since the real exchange rate does not change, we can use the monetary approach equation, E = M s M s & & L ( r & ; Y & ) L ( r; Y ) A permanent increase in money demand at any nominal interest rate leads to a pro- portional appreciation of the long-run nominal exchange rate. Intuitively, the level of prices for any level of nominal balances must be lower in the long run for money...
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