Tutorial 8

Chapter 10: Macroeconomic equilibrium in the short run

Open question: Exercise 2 from the book.

Open question: Exercise 4 from the book.

Open question: Exercise 5 from the book.

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Open question: Exercise 6 from the book.

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Extra question: Exercise 11 from the book.

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i* IFM

Interest rate

IS

A

IS ́IS ́

Output

B

C

TR’TR

D

Chapter 11: International capital flows and macroeconomic equilibrium

Multiple choice questions

Question 1

Assume a small, open home country under a flexible exchange rate regime with full capital mobility. The economy is initially in a general equilibrium at point A. If the central bank pursues an expansionary monetary policy which shifts the TR curve to TR’, a new equilibrium is reached at which ONE of the following?a. At point C, since the expansionary monetary policy lowers the domestic interest rate below the level of the international rate of return.Feedback: Incorrect. Interest rate parity condition demands that the domestic interest rate equals the international rate of return. The lower domestic interest rate triggers capital outflow and thus leads to exchange rate depreciation. International competitiveness increases net exports and shifts the IS curve to IS’. A new equilibrium occurs at point B. See the discussion of Figure 11.8, panel (b).Page reference: 277b. At point A, because due to the interest rate parity condition, the TR’ curve must shift back to TR.Feedback: Incorrect. Under flexible exchange rates, differences between the domestic interest rate and the international rate of return induce changes of the exchange rate. The lower domestic interest rate triggers capital outflow and thus leads to exchange

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rate depreciation. International competitiveness increases net exports and shifts the IS curve to IS’. A new equilibrium occurs at point B. See the discussion of Figure 11.8, panel (b).Page reference: 277c. At point D, because the expansionary monetary policy induces an exchange rate depreciation which shifts the IS curve to IS’, but due to the interest rate parity condition, the TR’ curve must shift back to TR.Feedback: Incorrect. At point D, the interest rate parity condition is not fulfilled. The correct answer is point B, because the expansionary monetary policy induces an exchange rate depreciation which shifts the IS curve to IS’.Page reference: 277*d. At point B, because the expansionary monetary policy induces an exchange rate depreciation which shifts the IS curve to IS’.Feedback: Correct. See the discussion of Figure 11.8, panel (b).

Question 2Under a flexible exchange rate system, a [(A)__________] policy expansion would lead to [(B) ______________].a. (A) fiscal; (B) an increase in real GDPb. (A) fiscal; (B) an increase in the interest rateFeedback: Incorrect. This cannot be correct: see Figure 11.1.Page reference: 267*c. (A) monetary; (B) an increase in real GDPFeedback: Correct. See Figure 11.8.Page reference: 277d. (A) monetary; (B) decrease in the interest rateFeedback: Incorrect. This cannot be correct: see Figure 11.1.Page reference: 267

Question 3Assume a small open economy with a flexible exchange rate system. An increase in the foreign interest rate will lead to*a. A rise in the domestic interest rate and a rise in domestic GDPFeedback: Correct. See Figure 11.6.Page reference: 279b. A fall in the domestic interest rate and a fall in domestic GDPFeedback: Incorrect. See Figure 11.6.Page reference: 279c. A rise in the domestic interest rate and a fall in domestic GDPFeedback: Incorrect. See Figure 11.6.Page reference: 279d. A fall in the domestic interest rate and a rise in domestic GDPFeedback: Incorrect. See Figure 11.6.Page reference: 279

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Open question: Exercise 1 from the book.

Open question: Exercise 9 from the book (floating exchange rate only).

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Open question: Exercise 10 from the book (floating exchange rate only).

Extra question: Exercise 7 from the book.

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