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1、“National saving can be used domestically or internationally.”Explain the basis for this Answers: Saving can be used to make investments. The country can use its national saving to make domestic real investments in new production capital (buildings, machinery and software), in new housing, and in additions to inventories, or it can use its national saving to invest in foreign financial assets. If it uses its national saving to make domestic real investment, benefits to the nation include the increases in production capacity and capabilities that result from new production capital and the housing services that flow from a larger stock of housing. If it uses its national saving to make foreign investments, benefits to the nation include the dividends, interest payments, and capital gains that it earns on its foreign investments, which add to the national income of the country in the future.

2. “For a country that has a surplus in its current account and wants to reduce this surplus, one Answers: Disagree. A shift to saving more would tend to increase the surplus, not reduce it. The current account balance equals net foreign investments, and net foreign investment is the difference between national saving and domestic real investment. If national saving increases, then net foreign investment tend to increases, and the current account balance tends to increase (the surplus tends to increase).

3. What are the major types of transactions or activities that result in supply of foreign currency in

Answers: Imports of goods and services result in demand for foreign currency in the foreign exchange market. Domestic buyers often want to pay using domestic currency, while the foreign sellers want to receive payment in their currency. In the process of paying for these imports, domestic currency is exchanged for foreign currency, creating demand for foreign currency. International capital outflows result in a demand for foreign currency in the foreign exchange market. In making investments in foreign financial assets, domestic investors often start with domestic currency and must exchange it for foreign currency before they can buy the foreign assets. The exchange creates demand for foreign currency. Foreign sales of this country’s financial assets that the foreigners had previously acquired and foreign borrowing from this country are other forms of capital outflow that can create demand for foreign currency.

4. A British bank has acquired a large number of dollars in its dealings with its clients.

Answers: The British bank could use the interbank market to find another bank that was willing to buy dollars and sell pounds. The British bank could search directly with other banks for a good exchange rate for the transaction, or it could use a foreign exchange broker to identify a good rate from another bank. The British bank should be able to sell its dollars to another bank quickly and with very low transactions costs.

5. For an investment in a foreign-currency-denominated financial asset, part of the return comes

Answers: Agree. As an investor, I think of my wealth and returns from investments in terms of my own currency. When I invest in a foreign-currency-denominated financial asset, I am(actually or effectively) buying both the foreign currency and the asset, Part of my overall return comes from the return on the asset itself--for instance, the yield or rate of interest that it pays. The other part of my return comes from changes in the exchange-rate value of foreign currency. If the foreign currency increases in value (relative to my own currency) while I am holding the foreign asset, the value of my investment (in terms of my own currency) increases,

and I have made an additional return on my investment. (Of course, if the exchange-rate value of the foreign currency goes down, I make a loss on the currency value, which reduces my overall return.)

6、What is the difference between a clean float and a managed float?

Answers: In the clean boat, the government allows the exchange-rate value of its currency to be determined solely by private (or nonofficial) supply and demand in the foreign exchange market, the government takes no direct actions to influence exchange rates. In a managed float, the government is willing to and sometimes does take direct actions to attempt to influence the exchange-rate value of its currency. For instance, the monetary authorities of the country may sometimes intervene in the market, buying or selling foreign currency (in exchange for domestic currency) in an effort to influence the level or trend of the floating exchange rate. 7. A government has just imposed a total set of exchange

Answers: The exchange controls are intended to restrain the excess private demand for foreign currency (the source of the downward pressure on the exchange-rate value of the country's currency). Thus, some people who want to obtain foreign currency, and who would be willing to pay more than the current exchange rate, do not get to buy the foreign currency. This creates a loss of well-being for the country as a whole because some net marginal benefits are being lost. Furthermore, these frustrated demanders are likely to turn to other means to obtain foreign currency. They may bribe government officials to obtain the scarce foreign currency. Or they may evade the exchange controls by using an illegal parallel market to obtain foreign currency (typically at a much higher price than the official rate).

8What are the key features of the international currency experience in the period between the Answers: Key features of the interwar currency experience were that exchange rates were highly variable, especially during the first years after World War I and during the early 193Os. Speculation seemed to add to the instability, and governments sometimes appeared to manipulate the exchange-rate values of their currencies to gain competitive advantage One lesson that policymakers learned from this experience was that fixed exchange rates were desirable to constrain speculation and variability in exchange rates, as well as to constrain governments from manipulating exchange rates. These lessons are now debated because subsequent studies have shown that the experience can be explained or understood in other ways. Exchange-rate changes in the years after World War I tended to move in ways consistent with purchasing power parity; which suggests that the fundamental problems were government policies that led to high inflation rates in some countries, The currency instability or the early 193Os seems to be reflecting the large shocks caused by the global depression. Indeed, the research suggests that it may not be possible to keep exchange rates fixed when large shocks hit the system.

13. Why was there so much private lending to developing countries from The surge in bank lending to developing countries during I 974-1982 had these main causes: (1 ) a rise in bank funds from the “petrodollar” deposits by newly wealthy oil exporting governments, (2) bank and investor concerns that investments in industrialized countries would not be profitable, because the oil shocks had created uncertainty about the strength of these economies, (3) developing countries' resistance to foreign direct investment, which led these countries to prefer loans as the way to borrow internationally, and (4) some amount of herding behavior by bank lenders, which built on the momentum of factors (1) through (3) and led to overlending. 15. Explain the effect of each of the following on the LM cure: a. The country's central bank decreases the money supply. b. The country's interest rate increases.

Answers: a. A decrease in the money supply tends to raise interest rates (and lower domestic

product). Thus, the LM curve shifts up (or to the left).

b. An increase in the interest rate does not shift the LM curve. Rather, it results in a movement along the LM curve.

16. Explain the effect of each of the following on the FE curve: a. Foreign demand for the country's exports increases. b. The foreign interest rate increases. c. The country's interest rate increases.

Answers: a. An increase in foreign demand for the country's exports tends to drive the country's overall international payments into surplus. To reestablish payments balance, the country's domestic product and income could be higher (so imports increase), or the country's interest rates could be lower (to create a capital outflow and reduce the country's financial account balance). Thus, the FE curve shifts to the right or down\

b. An increase in the foreign interest rate tends to drive the country's overall international payments into deficit because of capital outflows seeking the higher foreign returns. To reestablish payments balance, the country's domestic product could be lower (to reduce imports), or its interest rates could be higher (to reverse the capital outflow). Thus, the FE curve shifts to the left or up.

c. An increase in the country's interest rate does not shift the FE curve. Rather, it results in a movement along the FE curve.

17. “A country with a deficit in its overall international payments runs the risk of increasing Answers: Disagree. The risk is rising unemployment, not rising inflation. The deficit in its overall international payments puts downward pressure on the exchange-rate value or the country's currency. The central bank must intervene to defend the fixed exchange rate by buying domestic currency and selling foreign currency in the foreign. exchange market. As the central bank buys domestic currency, it reduces the monetary base and the country's money supply falls. The tightening of the domestic money supply puts upward pressure on the country's interest rates. Rising interest rates reduce interest-sensitive spending, lowering aggregate demand, domestic product, and national income, The risk is falling real GDP and rising unemployment.

18. What does perfect capital mobility mean for the effectiveness of monetary and fiscal policies

Answers: Perfect capital mobility essentially eliminates the country's ability to run an independent monetary policy. The country must direct its monetary policy to keeping its interest rate in line with foreign interest rates. If it tried to tighten monetary policy, its interest rates would start to increase. but this would draw a massive inflow of capital. To defend the fixed exchange rate, the central bank would need to sell domestic currency into the foreign exchange market. This would increase the domestic money supply, forcing the central bank to reverse its tightening. if it tried to loosen monetary policy, interest rates would begin to decline, but the massive capital outflow would require the central bank to defend the fixed rate by buying domestic currency. The decrease in the domestic money supply forces the central bank to reverse its loosening.

Perfect capital mobility makes fiscal policy powerful in affecting domestic product and income in the short run. For instance, expansionary fiscal policy tends to increase domestic product, but the increase in domestic product could be constrained by the crowding out of interest-sensitive spending as interest rates increase. With perfect capital mobility the domestic interest rate cannot rise if foreign interest rates are steady, so there is no crowding out. Domestic product and income increase by the full value of the spending multiplier.

19. “According to the logic of the J-curve analysis, a country that revalues its currency should Answers: Agree. Consider the value of the country's current account measured in foreign