STUDY UNIT 7

Question 1

what is the impact of the nominal interest rate (i) on the goods market?

Answer 1

an increase in the interest rate leads to a decrease in investment spending, the demand for goods and level of output and income (i increase-> I decrease-> Z decrease-> Y decrease)

a decrease in output and income is a multiplier of the decrease in investment spending.

Question 2

describe the equilibrium in the financial market

Answer 2

the equilibrium both domestic and foreign bonds must have the same expected rate of return

Question 3

what relationship does the domestic interest rate and nominal exchange rate have with each other and what equation describes this relationship?

Answer 3

a positive relationship

E= 1+i/1+i*xEe

E= nominal exchange rate
Ee= foreign value
i= domestic interest rate
i* interest rate in the other country

Question 4

why does the rand appreciate if the domestic interest rate rises relative to the foreign interest rate?

Answer 4

an increase in our domestic interest rate relative to the foreign interest rate, all things remain equal and that increases the attractiveness of our bonds.

Question 5

what happens on the balance of payments when the rand appreciate if the domestic interest rate rises relative to the foreign interest rate?

Answer 5

a capital inflow occurs and we experience a higher demand for rands on the foreign exchange market. this increase the demand for rand results in an appreciations of the domestic currency.

Question 6

what relationship does domestic interest rate have with the exchange rate and describe this relationship with chains of events.

Answer 6

a positive relationship

i decreases-> E decreases-> depreciations

i increases-> E increases-> appreciation

Question 7

what happens when interest rates increase

Answer 7

a depreciation occurs leading to a decrease in the domestic interest rate. this causes domestic bonds to be less attractive which causes a capital outflow

Question 8

what’s the impact on the exchange rate when interest rates increases

Answer 8

increase in capital inflows, nominal exchange rate increases and the domestic currency appreciates, the price of exports and net exports decreases which will cause a decrease on the level of output and income

Question 9

what’s the impact on the IS-LM model when interest rates increases

Answer 9

upward shift on the LM curve and a leftward movement along the IS curve

Question 10

what’s the impact on the financial market when government spending increases?

Answer 10

interest rate is unchanged, an increase in the level of output and income will increase the demand for money and quantity of money (Y increase-> Md increase-> M increase)

Question 11

what’s the impact on the trade balance when government spending increases?

Answer 11

the increase of the level of output and income results in an increase in imports and a decline on the trade balance (Y increases-> IM increase-> NX decreases)