Exercise
Set 14
MONEY, INTEREST RATES AND EXCHANGE
RATES
I. Objectives
- To obtain the equilibrium
interest rate
- To explain changes in
interest rates and exchange rates.
II. Data
- The equation for money
demand is:
(1) Md
= P(2 - 10r + 0.04Y),
where Md
is nominal money demand, P
is the price level, and Y
is real GDP.
- The equation for money
supply is:
(2) Ms
= M,
where M
is the nominal money supply (fixed by the Fed).
- For given values of Y, P
and M,
obtain the equilibrium interest rate.
- Click
on Gimme
Rates!
to confirm.
III. Questions
- From equation (1), we
observe that, ceteris paribus,
money demand will increase if:
- GDP [ increases |
decreases
].
- The price level [ increases
| decreases
].
- The interest rate [ increases
| decreases
].
- Suppose the money supply
is 400, the price level is 200, and real GDP
is 3000 .
- Write the equation
signifying equilibrium in the money market.
- Compute the equilibrium
interest
rate.
- Provide a sketch of
the
money market. Indicate the eqbm value of r
on the graph.
- In each case below,
describe the effect on the equilibrium
interest rate and provide the corresponding sketches:
- The central bank
increases money supply by 10%.
- The country's GDP
falls by 5%.
- The price level
rises by 20%.
- Consider the relationship
between interest rates and exchange rates.
- 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.
- 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