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Chapter 13 answers - TUTORIAL FOR FOREIGN EXCHANGE MARKET...

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TUTORIAL FOR FOREIGN EXCHANGE MARKET QUESTIONS: 1. If the European price level rises by 5% relative to the price level in the United States, what doest the theory of purchasing power parity predict will happen to the value of the euro in terms of dollars? It predicts that the value of the euro will fall 5% in terms of dollars. 2. If the demand for a country’s export is raised, will the country’s currency tend to appreciate or depreciate in the long run? In the long run, the fall in the demand for a country’s exports leads to a depreciation of its currency, but the higher tariffs lead to an appreciation. Therefore, the effect on the exchange rate is uncertain. Opposite effect in the case of higher demand. 3.If the British central bank prints money to reduce unemployment, what will happen to the value of the pound in the short run and in the long run? The pound depreciates but overshoots, declining by more in the short run than in the long run. Consider Britain the domestic country. The rise in the money supply leads to a higher domestic price level in the long run, which leads to a lower expected future exchange rate. The resulting expected depreciation of the pound raises the expected return on foreign deposits shifting R F to the right. The rise in the money supply lowers the interest rate on pound deposits in the short run, which shift R D to the left. The short-run outcome is a lower equilibrium exchange rate. However, in the long run, the domestic interest rate returns to its previous value,
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