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ExerciseSeven:MonetaryApproachtoExchangeRate1.AccordingtoMonetaryApproach,ifthereisadownwardshiftinthedemandfordollarsbecauseofincreaseduseofcreditcards,whatistheeffectontheexchangerate?Answer:Theincreaseduseofcreditcardswillresultinadownwardshiftinthedemandfordollars.Thiswillreducethepriceofdollars,andthusleadtoadepreciationofthedollar(anincreaseinthepriceofforeignexchange).2.Ifpricesareperfectlyflexible,thena4percentincreaseinthemoneysupplywill(a)notchangethedemandforrealbalances.(b)increasetheexchangerateby4percent.(c)increasethepricelevelby4percent.(d)havenoeffectonincome.(e)alloftheabove.Answer:(e)3.ExpectedinflationinJapanis1percentandexpectedinflationintheUSis3percent.TheinterestrateinJapanis2percent.Ifrealinterestparityholdsthen(a)thedollar/yenexchangeratewillappreciate2percent.(b)theUSinterestratemustbe4percent.(c)theUSinterestratemustbe2percent.(d)USinvestorswillbeginbuyingJapaneseassets.(e)JapaneseinvestorswillbeginbuyingUSassets.Answer:(b)4.TheUSmoneysupplyincreasesby3percent,theBritishmoneysupplyincreasesby4percentandBritishincomesincreaseby1percent.Underthemonetarymodelofexchangerates,thedollar/poundexchangeratewouldthen(a)increaseby8percent.(b)depreciateby2percent.(c)notchange.(d)appreciateby2percent.(e)decreaseby8percent.Answer:(c)5.IntheDornbuschovershootingmodel,anincreaseintheUSmoneysupplywillleadto(a)aninitialjumpinthepricelevelequaltotheincreaseinthemoneysupply.(b)alarge,immediateappreciationinthenominalexchangerate.(c)aninitialincreaseintherealinterestdifferentialbetweentheUSandCanada.(d)anincreaseintherealmoneysupply.(e)nochangeinthelong-runnominalexchangerate.Answer:(d)6.Uncoveredinterestparity(a)isaweakerhypothesisthancoveredinterestparity.(b)holdsonlyifinvestorsviewdomesticcurrencyandforeigncurrencyassetsasperfectsubstitutes.(c)holdswheninvestorscareaboutexchangeraterisk.(d)holdsbecauserisk-freearbitragedonotexist.(e)noneoftheabove.Answer:(b)7.Inthemonetarymodelofexchangerateswithflexibleprices,realdemandformoneyisa/an(a)increasingfunctionofincomeanddecreasingfunctionofinterestrate.(b)decreasingfunctionofincomeandincreasingfunctionofinterestrate.(c)increasingfunctionofincomeandincreasingfunctionofinterestrate.(d)decreasingfunctionofincomeanddecreasingfunctionofinterestrate.(e)Therealdemandformoneyisafunctionofothervariablesintheeconomy.Answer:(a)