1 Answer True or False. Brief explain your answer. No credit without explanation.

a Bretton Woods. During the Bretton Woods system countries with large current account surpluses were viewed by the market as candidates for devaluation?

b A country with relatively unstable money demand would find it advantageous to join a currency union at a lower level of monetary integration than would a country with relatively stable money demand.

c When real income decreases, the central bank can maintain the exchange rate fixed at E0 by purchasing foreign assets.

d Under the gold standard a perpetual surplus is impossible.

e Under the fixed rate regime foreign countries could hold their dollar exchange rates constant by setting their domestic interest rate equal to dollar interest rate.

2 Fixed versus Floating Exchange Rates.

Analyze a transitory increase in the foreign interest rate, R*. Under which type of exchange rate is there a smaller effect on output (fixed or floating)?

3 International Capital Market.

a How international trade in assets can make two countries better off?

b Explain Tobin's idea of \Don't put all your eggs in one basket."

c The following simple two-country question illustrates how countries are made better off by trade in assets. Imagine that there are two countries, Home and Foreign, and that residents of each own only one asset, domestic land yielding an annual harvest of kiwi fruit. Assume that the yield on the land is uncertain. Half the time, Home's land yields a harvest of 100 tons of kiwi fruit at the same time as Foreign's land yields a harvest of 50 tons. The other half of the time the outcomes are reversed. The Foreign's harvest is 100 tons, but the Home harvest is only

50. Suppose the two countries can trade shares in the ownership of their perspective assets.

Further assume that a Home (Foreign) resident that owns 25 percent of the Foreign (Domestic) land receives 25 percent of the annual Foreign (Domestic) kiwi fruit harvest. Calculate the expected value of kiwi fruit for each investor.

4 Use a figure to show and explain the effect of a currency devaluation on the economy under a Fixed Exchange Rate Regime.

5 Real and Monetary Shocks and the Choice of the Exchange Rate Regime

Using the DD-AA model compare and contrast how a exible and fixed exchange rate systems respond to real shocks (e.g. exogenous decrease in net exports). Include the relevant diagrams to support your answer.

6 Multiple Choice. Choose the one alternative that best completes the statement or answers the question. a Describe three types of gains from trades?

(a) trades of exchange rates for goods or services, trades of goods or services for property, and trades of gold for textiles

(b) trades of goods or services for goods or services, trades of goods or services for assets, and trades of assets for assets

(c) trades of imports for exports, trades of exports for imports, and trades of natural resources for financial assets

(d) None of the above.

b By fixing the exchange rate, the central bank gives up its ability to

(a) adjust taxes.

(b) increase government spending.

(c) inuence the economy through fiscal policy.

(d) depreciate the domestic currency.

(e) finuence the economy through monetary policy.

c People who are risk averse,

(a) value a collection of assets only on the basis of its expected returns.

(b) value a collection of assets only on the basis of the risk of that return.

(c) value a collection of assets not only on the basis of its expected returns but also on the basis of the risk of that return.

(d) no clear cut criteria exist.

(e) None of the above.

d Under the Gold standard, a country is said to be in balance of payments equilibrium when the current account balance is

(a) financed entirely by international lending without reserve movements.

(b) financed by international lending and with reserve movements.

(c) equal to zero.

(d) financed entirely by international lending and past gold reserves.

e What event started the Asian financial crisis in 1997?

(a) Indonesia's inability to pay its debts

(b) devaluation of Indonesia's currency

(c) Thailand's inability to pay its debts

(d) devaluation of Thailand's currency

(e) devaluation of Malaysia's currency