Exercise Set 14
MONEY, INTEREST RATES AND EXCHANGE RATES


I. Objectives

  1. To obtain the equilibrium interest rate
  2. To explain changes in interest rates and exchange rates.

II. Data


III. Questions

  1. From equation (1), we observe that, ceteris paribus, money demand will increase if:
    1. GDP [ increases | decreases ].
    2. The price level [ increases | decreases ].
    3. The interest rate [ increases | decreases ].
  2. Suppose the money supply is 400, the price level is 200, and real GDP is 3000 .
    1. Write the equation signifying equilibrium in the money market.
    2. Compute the equilibrium interest rate.
    3. Provide a sketch of the money market. Indicate the eqbm value of r on the graph.
  3. In each case below, describe the effect on the equilibrium interest rate and provide the corresponding sketches:
    1. The central bank increases money supply by 10%.
    2. The country's GDP falls by 5%.
    3. The price level rises by 20%.
  4. Consider the relationship between interest rates and exchange rates. 
    1. An increase in domestic interest rates, ceteris paribus, will lead to capital [ inflows into / outflows from ] the country, causing its currency to [ appreciate / depreciate ]. Explain.
    2. Suppose the Fed buys government securities in an open-market operation. Ceteris paribus, what are the effects of the Fed's policy on: (i) Money supply? (ii) Interest rates? (iii) The value of the dollar in the foreign-exchange market?

Video: Solution to Section III Questions at
http://www.screencast.com/t/WVtOpT5c7zW