Under what conditions will one observe floating
exchange rates operating in the gold standard system
Many countries peg their exchange rates against
the US dollar. As a result they are likely to settle their overseas payments
through transfer and receipt of dollar balances held in US financial
institutions. At the same time, the US Federal Reserve System rarely intervenes
into the foreign exchange market. Would you expect eh absence of the Fed’s
participation in international transactions to have an effect on the US
official reserve settlements balance ORS? Why or Why not?
Explain why the expectation of inflation in
country A will lead to a higher nominal rate of interest on securities
denominated in A’S currency, but have no effect the real rate or interest.
On March 14, 2009 the NY times reported that the
Prime Minister of China expressed concern about the safety of China’s $trillion
investment in American Government debt, the worlds largest such holding, and
urged the Obama administration to offer assurances that the securities would
maintain their value. While economists dismiss the possibility of the US
defaulting on its obligations, they say china could face steep losses in the
event of a sharp rise in the US interest rates or a plunge in the value of the
For a number of years, China has had a current
account surplus with the US, which it uses to finance the Purchase of US
government debt. IF china were to stop purchasing US debt, what effect would it
have on its exchange rate, real GDP, and current account?
Would China benefit from switching its holdings
of US debt to the debt of other countries?
What economic polies might the US pursue to
reassure the Prime Minister that his country will not face serious financial
losses form holding US Debt?
What Information would be needed to determine if
the benefits of such assurances are worth the cost?
Does an increase in foreign holdings of US
government securities pose an economic danger to the buyer? Explain
Suppose the central bank of a small country
under fixed exchange rates is faced with an increase in the foreign interest
rate. What is the effect on its holding of international reserves? On its money
supply? Can the central bank offset these effects through financial transactions?
The term “Original Sin” has been adopted to
describe the practice of borrowing from abroad and promising to repay the
interest and principal of the debt in foreign currency?
Why do debtor countries engage in the practice?
What are the dangers to debtors and creditors?
Does Original Sin transfer the cost of default
from debtors to Creditors? Explain
Are there benefits to the debtor from engaging
in original sin?
How might creditors protect themselves against
12. Devaluation of a country’s currency may be undertaken to
achieve three possible goals:
a. Reduction of a current account deficit
b. A higher level of real GDP.
c. Higher Government revenue from seignorage
Suppose that the devaluation is followed by an equi-
proportionate increase in the domestic price level through wage and price
indexation or commodity arbitrage. Will the above goals be met?
13. Suppose there is a permanent incase in the foreign
interest rate. What happens to the economy under a floating exchange rate? How
does your answer depend on whether the change reflects a rise in the foreign
real interest rate in foreign inflationary expectations?
14. The constraints of the Gold standard are blamed by some
economists for the severity of the 1929-33 worldwide economic contractions.
Evaluate the argument sin support of this claim.
15. A small country faces three types of economic shock:
A. Increased Demand for Money Balances
B. Increased Foreign Rate of interest
C. Reduction in foreign Demand for exports
Analyze each shock to determine whether a hard peg fixed or
a floating exchange rate would provide better protection against the shock.
16. Explain the role of the dollar in the operation of the
Bretton Woods System.
A. Why did the US withdraw form the Bretton Woods System?
Was Bretton Woods preferable to the international monetary
system that succeeded it?