Miami University Rate of Interest Discussion

Description

Instructions: Please read Chapter 12 Exchange Rates II: The Asset Approach in the Short Run in your textbook (p. 424 – 434; 437 – 442; 445 – 450; 453 – 457). Type up your answers to the following questions:

In equation (12-1), what is the endogenous (output) variable and what are the exogenous (input) variables?
Using the FX market graph in your textbook (Figure 12-2, US is Home country while Eurozone is Foreign country), if current spot exchange rate is lower than the equilibrium level, which deposit offers a higher return and how does arbitrage push the FX market toward an equilibrium?
Using the FX market graph in your textbook (Figure 12-2, US is Home country while Eurozone is Foreign country), if the European Central Bank increases interest rate in the Eurozone, which curve shifts and how does equilibrium spot exchange rate change as a result?
How does the assumption regarding price level change according to the time horizon under consideration in the money market model?
In the short run, if there is a shortage in the money market, how does the nominal interest rate change to clear the market?
In the short run, how does an increase in money supply affect the nominal interest rate?
Use the short-run asset approach to predict the effect of a temporary increase in money supply in the U.S. on expected future exchange rate of dollar against euro and spot exchange rate of dollar against euro.
Use both short-run asset approach and long-run monetary approach to predict the effect of a permanent increase in money supply in the U.S. on expected future exchange rate of dollar against euro, spot exchange rate of dollar against euro, and the adjustment from short run to long run.
If a country adopts a fixed exchange rate policy, can it use effective monetary policy in response to a recession? Why?
What is the trilemma?

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