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Unformatted text preview: f. Suppose the Bank of Korea sought to implement policy that would cause the Korean won to appreciate relative to the Japanese yen. What ranges of the money growth rate (assuming positive values) would allow the Bank of Korea to achieve this objective? Answer: Using the same reasoning as previously, the objective is for the won to appreciate: % D E e won /¥ , This can be achieved if the Bank of Korea allows the money supply to grow by less than 7% each year. The diagrams on the following page show how this would affect the variables in the model over time. 8. This question uses the general monetary model, in which L is no longer assumed constant and money demand is inversely related to the nominal interest rate. Con- sider the same scenario described in the beginning of the previous question. In addi- tion, the bank deposits in Japan pay 3% interest; i ¥ 5 3%. a. Compute the interest rate paid on Korean deposits. Answer: Fisher effect: ( i won 2 i ¥ ) 5 ( K 2 J ) Solve for i won 5 (6% 2 1%) 1 3% 5 8% b. Using the definition of the real interest rate (nominal interest rate adjusted for inflation), show that the real interest rate in Korea is equal to the real interest rate in Japan. (Note that the inflation rates you calculated in the previous question will apply here.) Answer: r ¥ 5 i ¥ 2 J 5 2% 2 1% 5 1% r won 5 i won 2 K 5 8% 2 6% 5 2% c. Suppose the Bank of Korea increases the money growth rate from 12% to 15% and the inflation rate rises proportionately (one for one) with this increase. If the nominal interest rate in Japan remains unchanged, what happens to the interest rate paid on Korean deposits? Answer: We know that the inflation rate in Korea will increase to 9%. We also know that the real interest rate will remain unchanged. Therefore: i won 5 r won 1 K 5 1% 1 9% 5 10%. S-18 Solutions n Chapter 3 Exchange Rates I: The Monetary Approach in the Long Run Solutions n Chapter 3 Exchange Rates I: The Monetary Approach in the Long Run S-19 d. Using time series diagrams, illustrate how this increase in the money growth rate affects the money supply, M K ; Korea’s interest rate; prices, P K ; real money supply; and E won /¥ over time. (Plot each variable on the vertical axis and time on the hor- izontal axis.) Answer: See the following diagrams. M K 1 2 P K T Time Time M K / P K Time i won T Time E won/Y Time Bank of Korea increases money growth rate 9. Both advanced economies and developing countries have experienced a decrease in inflation since the 1980s (see Table 3-2 in the text). This question considers how the choice of policy regime has influenced this global disinflation. Use the monetary model to answer this question. a. The Swiss Central Bank currently targets its money growth rate to achieve pol- icy objectives. Suppose Switzerland has output growth of 3% and money growth of 8% each year. What is Switzerland’s inflation rate in this case? Describe how the Swiss Central Bank could achieve an inflation rate of 2% in the long run through the use of a nominal anchor. Answer: From the monetary approach: S 5 S 2 g S 5 8% 2 3% 5 5%. If the Swiss Central Bank wants to achieve an inflation target of 2%, it would need to re- duce its money growth rate to 5%: * S 5 S 1 g S 5 2% 1 3% 5 5%....
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- Winter '13
- Exchange Rate, japan, Foreign exchange market, United States dollar