Econ 141 SAMPLE Final Exam

1. Discuss the relationship, if any, between the US current account deficit and capital formation in the United States. Do you think there is a risk of a sudden depreciation of the dollar when the rest of the world decides not to lend to the US? 2. Explain how the expected rate of return in dollars of a Euro denominated deposit changes as the dollar per euro exchange rate changes. What did you assume about the expected future exchange rate in order to answer the question? Draw and carefully label a figure that illustrates this relationship. Illustrate interest parity in the figure. 3. In Dornbusch's model an increase in the level of the money supply can cause the exchange rate to depreciate by more than its long level in the short run. Set out all the assumptions needed to support this conclusion. Be sure to explain the role of slow adjustment of prices. Assume that output starts at full employment and remains unchanged. 4. The monetary approach model predicts that, because prices immediately jump to their equilibrium level, a permanent increase in the growth rate of the money supply can generate an immediate depreciation of the exchange rate followed by a higher rate of depreciation over time. Set out the assumptions needed to support this conclusion. Be sure to explain the role of PPP, changes in nominal interest rates and the demand for real money balances. 5. Assume a small open economy with a flexible exchange rate. Also assume that output prices are temporarily fixed but that output can adjust to aggregate demand. Why must the exchange rate appreciate as domestic output rises to maintain equilibrium in the goods market (hint the DD curve)? Why must the exchange rate depreciate as income rises in order to maintain equilibrium in the money and foreign exchange markets (the AA curve)? 6. For the question 5 economy illustrate the effects of a temporary and permanent increase in the level of the money supply. 7. Suppose that the small open economy described in question 5 adopts a fixed exchange rate against the US dollar. How would a permanent change in the central bank's holdings of domestic credit affect the equilibrium values of domestic output and prices? What would happen to the central bank's holding of international reserve assets? OVER

8. The US dollar was the reserve currency in the Bretton Woods system of fixed exchange rates. What obligations did the US have under this system? What obligations did other countries have? In this system a relatively expansionary monetary policy by the United States was blamed for exporting inflation to the rest of the world. Explain and evaluate the argument. 9. Since 1974 the US dollar has floated against other major currencies but US policy has continued to have an important impact on other countries. Assume the US is one large country and the rest of the world another large country and that there is a free float. Show that for a given real exchange rate one combination of home output, Y, and foreign output, Y!, clears both goods markets. (Hint FF and HH curves). 10. Use your answer to question 9 to predict the effects of a fiscal expansion in the United States. Is the US again exporting inflation?