Question

1.

Suppose policy makers want to reduce NX and keep Y constant. Which of the following policies would most likely achieve this?

Group of answer choices

A real exchange rate appreciation and a tax cut.

Encourage the country's trading partners to implement policies that will decrease foreign income.

A decrease in government spending.

A decrease in government spending and an increase in the real exchange rate.

A real exchange rate appreciation.

2.

Suppose that the domestic interest rate is 5% and that the foreign interest rate is 8%. Also assume that the domestic currency is expected to depreciate by 4% during the coming year. Given this information, we know that:

Group of answer choices

the interest parity condition holds.

individuals will only hold domestic bonds.

individuals will only hold foreign bonds.

the purchasing power parity holds.

individuals will be indifferent about holding domestic or foreign bonds.

3.

Suppose Australia's one-year interest rate is 4% per year, while a foreign country has a one-year interest rate of 6% per year. Ignoring risk and transaction costs, an Australian investor should invest in foreign bonds as long as the expected yearly rate of depreciation of the foreign currency is:

Group of answer choices

less than 1%.

less than 5%.

greater than 5%.

greater than 2%.

less than 2%.

4.

For this question, assume that equilibrium output is determined in the ZZ-Y diagram. Further assume that policy makers' goals are: (1) to achieve balanced trade (i.e., NX = 0); and (2) to achieve the natural level of output, say Yn. Now suppose that the initial level of equilibrium output is equal to Y_n (i.e., Y = Y_n) and that a trade deficit exists at this initial level of output. Which of the following policy actions would most likely enable the policy makers to achieve their two goals simultaneously?

Group of answer choices

A decrease in government spending.

A decrease in taxes and increase in the real exchange rate.

Convince the country's trading partners to pursue policies that will cause an increase in foreign income.

A decrease in the real exchange rate.

None of the other answers is correct.

5. For this question, assume that a country experiences a permanent reduction in its saving rate. Which of the following will occur as a result of this reduction in the saving rate, according to Solow model without technological progress?

Group of answer choices

a permanently higher growth rate of output

a permanently slower growth rate of output

a permanently lower level of output per worker

none of the other answers is correct

no permanent effect on the level of output per capita

6.

Why do banks maintain a certain level of bank capital?

Group of answer choices

These funds are reserved as salary bonuses for top management.

These are funds to be invested in emerging market economies.

These precautionary funds are held against the illiquidity risks of loans and bonds.

These funds are required to satisfy shareholders in annual statements.

These funds are set aside for taxation purposes.

Answer 1

Q1) The answer is (a) A real exchange rate appreciation and a tax cut.

The appreciation of the real exchange rate will reduce exports and the net exports will fall. This will lead to a decline in Y. Now this is compensated by a decrease in the tax rate which leads to and increases in Y such that Y remains constant.

All other combinations do not achieve the required objective and are hence wrong

Q2) The answer is (c) individuals will only hold foreign bonds

As per the interest parity condition, the country with a higher interest rate should see a depreciating currency to prevent any arbitrage opportunities. The opposite is happening here and there are profits to be made by investing in the foreign country.

Q3) The answer is (e) less than 2%.

For the eno arbitrage conditon to hold, the depreciation of foreign country should be equal to the interest differential = 6 - 4 = 2%. At a lesser depreciation, there are profits to be made by investing in the foreign currency.

All other options are wrong as they misrepresent the interest parity condition.