Open Economy Flashcards
When the pound appreciates relative to the dollar, the dollar price of the pound
Increases
Assume the IPP condition holds and that the U.S. interest rate is less than the UK, we know that investors expect:
The pound to depreciate
Exports will decrease when there is
An increase in the real exchange rate
If you want to increase NX but keep Y constant:
You should reduce government spending and reduce the real exchange rate
In an open economy under flexible exchange rates, an expansionary monetary policy will cause
An increase in output, exports and a reduction in the exchange rate
If the exchange rate between two countries is expected to remain fixed at its current rate then
Nominal interest rates must be equal in the two countries
What will cause the real exchange rate to increase?
A reduction in the foreign price level
Under a fixed exchange rate what happens?
A country gives up a powerful tool (the exchange rate) for correcting trade imbalances or changing the level of economic activity
Expectations that a devaluation may be coming can trigger
An exchange rate crisis
What does the current exchange rate depend on?
1) current and expected domestic and foreign interest rates for each year over n years
2) the expected exchange rate n years from now
What are the two exceptions for when flexible exchange rates are preferable over fixed?
1) a group of countries are tightly integrated (perhaps choose a common currency)
2) when the CB cannot be trusted to have a responsible monetary policy under flexible exchange rates
For countries to constitute an optimal currency area, which two conditions must be satisfied?
1) experience similar shocks
2) have high factor mobility
What is a hard peg?
The symbolic or technical mechanism by which a country plans to maintain exchange rate parity
Define dollarism?
An extreme form of hard peg - introducing dollars as a domestic currency
