Econ 110B Ch20 Solutions

Econ 110B Ch20 Solutions - Economics 110B Practice...

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Economics 110B Practice Questions for Chapter 20 Solutions 1) In an open economy, there are two components of demand that change as the domestic nominal interest changes: investment and net exports. First, a reduction in i (assume zero inflation) will cause investment to increase. This causes an increase in demand for domestic goods and output. Second, as i falls, the demand for the domestic currency drops, causing a depreciation. This depreciation causes NX to rise and demand for domestic goods to rise even more. 2) The IP curve represents the combinations of i and E that maintain the interest parity condition. As i falls, foreign bonds will have a higher expected return. The demand for the dollar will fall causing an immediate depreciation. So, the drop in i causes E to fall. E will fall until all of the drop in i is offset by the expected appreciation of the dollar. 3) Domestic bonds will have a higher return causing the demand for the domestic currency to rise. The dollar will appreciate. It will continue to appreciate as long as the return on domestic bonds exceeds the return on foreign bonds. This immediate appreciation will equal an expected depreciation of the domestic currency that equates the expected returns. So, the dollar will appreciate by 2%. 4) Foreign bonds will have a higher return, causing the demand for the foreign currency to rise. The foreign currency will appreciate (the domestic currency will depreciate). The foreign currency will continue to appreciate (the domestic currency will depreciate) as long as the return on foreign bonds exceeds the return on domestic bonds. This immediate domestic depreciation will equal an
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This note was uploaded on 05/01/2011 for the course ECON 110B taught by Professor Peters during the Spring '07 term at UCSD.

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Econ 110B Ch20 Solutions - Economics 110B Practice...

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