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Chapter 12 DF_2011

# Chapter 12 DF_2011 - appreciation Appreciation will lead to...

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Lahore School of Economics Macroeconomics II In Class Assignment Chapter 12 – Conceptual Problems Question 10 a. Since there is floating exchange rate, the economy can employ expansionary  monetary policy. This will reduce the exchange rate and increase the income  levels b. If the other countries are facing recession, then cheaper exports of domestic  country will increase local employment at the expense of foreign employment.  However, if the foreign countries are facing inflationary pressures, then they  would welcome the appreciation of their currency. c. It could be termed as ‘begger-thy-neighbour” policy only of the other countries  are facing recession Chapter 12 – Technical Problems Question 1 An increase in the government purchases (G) will increase the level of output (Y) and  interest   rates,   (i).   This   will   attract   capital   inflows,   which   will   lead   to   currency

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Unformatted text preview: appreciation. Appreciation will lead to loss in competitiveness and net exports (NX) will be crowded out to the point where domestic output (Y) is back to the original level. In the end, level of output and interest rate will remain unchanged, and r = r*. Question 3 If the US interest rate is 4% and you expect the pound to depreciate by 6%, then the yield on British Government securities would have to be i F = 10% or more to make the purchase of British securities profitable. When capital is perfectly mobile, the domestic interest rate ‘i' is equal to the foreign interest rate, (i F ) adjusted for the expected exchange rate depreciation (risk premium). i = i F + , where = risk premium on domestic currency. Since risk θ θ premium is on the foreign currency, = – 6%. Thus, i θ F = 4 + 6 = 10%...
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Chapter 12 DF_2011 - appreciation Appreciation will lead to...

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