We have now covered some of the intricacies of exchange rate determination via the interest parity model. The following questions will force you to think and apply these models and assumptions.
1. 5 Pts. Under the Trump administration, imports from the EU were tariffed. How did this action change the long-run real exchange rate between the US and EU? How is the long-run nominal exchange rate affected? Utilize graphs to assist in answering this question.
2. 5 Pts. Why might it be true that relative PPP holds better in the long run than the short run? (Think about how import/export firms might react to large and persistent cross-border differences in the prices of a tradable good.)
3. 10 Pts. Sticky nominal prices and wages are central to macroeconomic theories, but just why might it be difficult for money prices to change from day to day as market conditions change? Apply this thought process to the following article: Law of One Price in Scandinavian Duty Free Stores __> PDF called Law of one Price
4. 5 Pts. Read / Watch the content in the following link: Federal Reserve Decision in March 2021. Using the Real Exchange Rate approach, explain what will happen to the US exchange rate with, say, Mexico. Utilize the domestic market / FX market graph in explaining your reasons. Imagine that the Federal Reserve decides to fight inflation, what will happen to the USD:MXN exchange rates via the domestic market/FX market graph? This is the link –> https://www.cnbc.com/2021/03/17/fed-decision-march-2021-fed-sees-stronger-economy-higher-inflation-but-no-rate-hikes.html
Answer the following questions that are based on Topics 7 & 8.
1. 7 pts. Suppose that interest parity does not hold exactly, but that the true relationship is R = R* + (Ee-E)/E + p , where p is a term measuring the differential riskiness of domestic versus foreign deposits. Suppose a permanent rise in domestic government spending, by creating the prospect of future government deficits, also raises , that is, makes domestic currency deposits more risky. Evaluate the policy’s output effects in this situation.
2. 5 pts. If a government initially has a balanced budget but then cuts taxes, it is running a deficit that it must somehow finance. Suppose people think the government will finance its deficit by printing the extra money it now needs to cover its expenditures. Would you still expect the tax cut to cause a currency appreciation?
3. 7 pts. If a country changes its exchange rate, the value of its foreign reserves, measured in the domestic currency, also changes. This latter change may represent a domestic currency gain or loss for the central bank. What happens when a country devalues its currency against the reserve currency? When it revalues? How might this factor affect the potential cost of holding foreign reserves? Make sure to consider the role of interest parity in formulating your answer.
4. 6 pts. Based on our discussion of a fixed exchange rate, how sustainable is a USD-pegged cryptocurrency. Review the content from the following link: Winklevoss Brothers and Pegged Cryptocurrency and discuss the potential threats and advantages of having a USD backed cryptocurrency. Utilizes any and all graphs from class when answering. –> use this think here https://www.cnbc.com/2018/09/10/winklevoss-firm-rolls-out-new-cryptocoin-pegged-to-us-dollar.html
Please use the powerpoints I added to answer questions
