Answer to Question #88200 in Macroeconomics for Courtney Bellm

Question

Consider the determination of real exchange rates in a large open economy with a flexible exchange rate regime. If today’s technology increase, e* will
Blank 1
. If tomorrow’s technology is expected to improve, e* will
Blank 2
. If M decreases, e* will
Blank 3
. If the government decreases G1 while keeps G2 unchanged, e* will
Blank 4
.

Note: For each of the above blanks, fill in one of the following three choices: A. increase; B. decrease; C. stay; D. none of A, B, and C.

Answer 1

If today’s technology increase, e* will

Increase

An increase in today’s technology is likely to lead to an increase in exports of products from the country. Therefore, imports will fall because; they will become relatively more expensive. Thus, domestic price of foreign currency, e will increase.

If tomorrow’s technology is expected to improve, e* will

Decrease

If tomorrow’s technology is expected to improve, domestic currency will have an increase demand. The investors would purchase the domestic assets leading to a decrease in e.

If M decreases, e* will

Decrease

When money supply (M) decreases, the LM curve shifts to the left. There is an infinite capital inflow as domestic currency gains higher returns. This will cause an increase in demand for the dollar that causes value of dollar to increase on foreign exchange market, thus, e decreases as dollar appreciates.

If the government decreases G1 while keeps G2 unchanged, e* will

Increases

The decrease in G1 while G2 keeps unchanged; there is a decrease in total expenditures. Therefore, IS curve shifts to the left which is a decrease in demand for dollar causing value of dollar to decrease on foreign exchange market. This will lead to an increase in e that is the dollar depreciates.

Note: For each of the above blanks, fill in one of the following three choices: A. increase; B. decrease; C. stay; D. none of A, B, and C.

Reference

https://www2.econ.iastate.edu/classes/econ302/alexander/Fall2003/openeconmacro/OpenEconomyMacroeconomics.pdf