Problem 1
Which of the following statements is correct? Devaluation is most effective when: (a) a country has a small export and import sector, since higher import prices then have little effect; (b) domestic wages and prices are very flexible; (c) nominal wages and prices adjust slowly; (d) the country is already at potential output.
Problem 3
A country discovers a new technology that will add significantly to its export capacity in five years' time. (a) What must happen to its real exchange rate in the long run? (b) Why does the exchange rate react immediately to the news rather than waiting till the new export supply comes on stream?
Problem 5
'Once the central bank is made independent, with a specified inflation target, the principal role of macroeconomic policy is to determine the real interest rate and hence the exchange rate.' Explain.
Problem 6
Because of China's sustained export success, many people in the West call for China's fixed exchange rate against the dollar to be revalued or for its currency to be floated in the expectation that it will then appreciate. (a) At its current stage of development, should China be running a deficit or surplus on the financial account of its balance of payments? (b) Given that its trade surplus in 2006 exceeded \(\$ 170\) billion, was China running a balance of payments surplus or deficit? (c) With such large monetary inflows, what was happening to China's foreign exchange reserves and the Chinese money supply? Must this be inflationary, or could the demand for money increase just as quickly?
Problem 9
A country faces a permanent fall in export demand. Would devaluation help? How else might internal and external balance be restored?
Problem 10
Because of the strength of long-run Asian demand for its mineral exports, markets conclude that the Australian real exchange rate will have to be permanently higher. Australian monetary policy is already much tighter. Draw a diagram showing the likely evolution over time of the exchange rate of the Australian dollar against sterling.
Problem 11
Rank the following three situations according to the ability of monetary policy to affect real output in the short run: (a) a closed economy; (b) an open economy with fixed exchange rates; (c) an open economy with floating exchange rates. Explain.
Problem 13
Because of the strength of long-run Asian demand for its mineral exports, markets conclude that the Australian real exchange rate will have to be permanently higher. Australian monetary policy is already much tighter. Suppose Australia now discovers vast new mineral deposits that will take five years to begin to exploit. What further effect, if any, will this have on the evolution of Australia's exchange rate? Illustrate in a diagram.
Problem 14
The following table shows the evolution of an index of \(\$ / £\) nominal exchange rate, and the behaviour of prices in each of two countries. In the initial years, monetary policy is very different; in the last three years both countries succeed in achieving inflation targeting at a low level. For simplicity, we assume that the inflation target is zero. (a) Calculate the evolution of the implied real exchange rate, setting the index initially at 100 . (b) Graph the nominal and real exchange rates. (c) What happens to the correlation between nominal and real exchange rates once inflation convergence is achieved?
