International Finance Exam #2

Front 1

Equation for the LM curve (real money demand curve)

Back 1

(money supply)/(price or CPI) = (nominal income)*(real demand for money)

Front 2

M/P = Y*L(i)

Back 2

(money supply)/(price or CPI) = (nominal income)*(real demand for money)

Front 3

What does the government do in order to enact fiscal expansion?

Back 3

Raises government spending

Front 4

When interest rates increase, what happens to the rate of investments?

Back 4

Rate of investments decreases

Front 5

Does investing become cheaper or more expensive when interest rates increase?

Back 5

More expensive

Front 6

What 3 characteristics does the Mundell-Fleming model argue cannot exist simultaneously in an open economy (also known as the unholy trinity, etc.)

Back 6

1. Fixed exchange rate
2. Free capital movement
3. Independent monetary policy

Front 7

Equation for the IS curve

Back 7

Y = C + I + G + NX

Front 8

A lower real interest rate has what effect on consumption?

Back 8

Increases consumption spending

Front 9

While usually upward sloped, the BoP curve in the Mundell-Fleming model can be horizontal at the level of the world interest rate. What condition is required for this?

Back 9

Perfect capital mobility

Front 10

What change in global interest rate causes the LM curve to shift to the right? (assuming perfect capital mobility)

Back 10

Decrease in global intrest rates

Front 11

In the IS-LM-BoP (Mundell-Fleming) model, what directional shift in the IS curve causes the LM curve to shift to the right? (assuming perect capital mobility?)

Back 11

Shift to the right of the IS curve

Front 12

In the Mundell–Fleming open economy model with perfect capital mobility, what happens to monetary policy?

Back 12

Monetary policy becomes ineffective

Front 13

In the IS-LM-FE model, an increase in the domestic interest rate causes what change in the flow of capital?

Back 13

It attracts an INFLOW of capital

Front 14

What does the real business cycle theory say?

Back 14

Random technological changes affect relative prices and cause cycles - policy is ineffective, maybe even harmful

Front 15

What is the New Keynesian (or post Keynesian) framework?

Back 15

Sticky prices & wages, market imperfections cause business cycles

Front 16

What does the downward slope of the IS curve represent?

Back 16

Increase in output as interest rate decreases (inverse relationship)

Front 17

What does the slope of the FE curve represent?

Back 17

Responsiveness of capital flows to changes in the interest rate differential (between domestic and world interest rates)

Front 18

What causes the FE curve to shift?

Back 18

imports
exports
capital flows
supply/demand of currencies in foreign exchange markets

Front 19

What effect does an increase of domestic interest rate have on capital flows (in the short run)?

Back 19

Causes an increase in capital inflow

Front 20

What happens if Consumption increases?

Back 20

IS shifts right, new domestic equilibrium with higher Y and i.

Imports also increase, macro equilibrium holds at higher interest rate.

Front 21

What happens if Domestic interest rates rise relative to foreign interest rate?

Back 21

Net capital inflows lead to appreciation of domestic currency

Domestic investment also falls, so IS shifts left

Front 22

What happens if Central Bank increases money supply (M)?

Back 22

Shifts LM right - new equilibrium with higher income and lower interest rate.

Front 23

What happens if Domestic income (Y) increases?

Back 23

Imports increase,
current account goes into smaller surplus (or larger deficit) (movement along FE curve)

Front 24

What are the 3 markets that the IS/LM/FE model summarizes?

Back 24

1. Domestic production, goods, and services markets (IS)

2. Domestic money market (LM)

3. Foreign currency market & balance of payments (FE).

Front 25

What would cause a balance of payments (BP) deficit?

Back 25

High real income attracts imports, creating current account deficit;

And/or...

Domestic interest rate is relatively low, leading to net capital outflow

Front 26

What would cause a balance of payments (BP) surplus?

Back 26

Relatively low real income and imports result in current account surplus;

And/or...

Domestic interest rate is relatively high, leading to net capital inflow

Front 27

What does a negative balance of payments indicate?

Back 27

A net decrease in foreign assets

Front 28

What does a central bank's assets include?

Back 28

Ownership of gov’t bonds
Deposits in commercial banks
Holdings of international currencies & assets

Front 29

What does a central bank's liabilities include?

Back 29

Currency issued by central bank
Deposits & reserves from commercial banks (required by Fed)

Front 30

What two things make up the Monetary Base?

Back 30

A central bank’s issued currency + reserves

Front 31

An official settlements balance greater than 0 has what effect on the currency?

Back 31

Appreciates the currency

Front 32

What 3 ways does the central bank change the money supply by?

Back 32

a. RESERVE REQUIREMENT (ie, 5% of a bank's deposits must be held in reserve)

b. DISCOUNT RATE (interest rate paid by banks when the borrow from central bank)

c. OPEN MARKET OPERATIONS (purchase/sale of government bonds; most frequently used method)

Front 33

How can the BP have both a current account and capital account deficit?

Back 33

Domestic currency is likely to lose value; degree depends on responsiveness of capital flows to interest rates (slope of FE curve)

Front 34

How can a domestic bank offset the effect on the domestic money supply (which is caused by intervention)?

Back 34

By buying government bonds

Front 35

If capital flows ARE very responsive to changes in the interest rate differential, what does the FE curve look like?

Back 35

It is flatter

Front 36

If capital flows ARE NOT very responsive to changes in the interest rate differential, what does the FE curve look like?

Back 36

It is steeper

Front 37

Why can't a country operate fully independent monetary policy under fixed exchange rates?

Back 37

Expansion of money supply lowers interest rates
Capital outflow
Imports increase, causes BP deficit
Government must buy domestic currency
---> Results in gov't having to undo initial policy

Front 38

Is monetary policy more influential in a fixed rate system or a floating rate system?

Back 38

Floating rate system

Front 39

Is fiscal policy more influential in a fixed rate system or a floating rate system?

Back 39

FIxed rate system

Front 40

If currency depreciates from IS/LM/FE equilibrium, what happens to IS curve?

Back 40

Shifts to the right

Front 41

Why does Expansionary domestic fiscal policy generate domestic budget deficit?

Back 41

Higher Y due to increase in G -

Higher r due to sale of bonds to finance deficit and increased demand for loanable funds.

Front 42

What difference does capital mobility make to fiscal policy under a floating exchange rate?

Back 42

After gov spending (G) increases, when capital mobility is high, the initial response is a NET CAPITAL INFLOW, as opposed to the increase in imports that occurs if capital mobility is low. The end result is that under high capital mobility, there is "feedback" in the form of a slight leftward shifts in r and Y, so the total rightward shift of r and Y are not as great as when capital mobility is low.