Lecture 10

Question 1

If the PPP holds, the real exchange rate is ______ and the nominal exchange rate changes when the price levels ________

Answer 1

1

change

Question 2

The _________ exchange rate will move in the direction to make PPPP true

Answer 2

nominal

Question 3

What are four things to remember about the PPP?

1. _________ exchange is a type of _________, and the value today also reflects anticipated __________ values
2. many ___________ (or components of goods) are _____________
3. __________ goods are not always perfect __________
4. even if the forces of PPP do not completely fix the ________ exchange rate, large and persistent movements in ________ exchange typically reflect changes in the price level home and abroad

Answer 3

1. foreign exchange is a type of asset, and the value today also reflects anticipated future values
2. many goods (or components of goods) are non-traded
3. tradable goods are not always perfect substitutes
4. even if the forces of PPP do not completely fix the real exchange rate, large and persistent movements in nominal exchange typically reflect changes in the price level home and abroad

Question 4

Does the exchange rate actually move to ensure that a dollar has the same real value in all countries at all times?

Answer 4

no, but they move in that direction

Question 5

What is Burgernomics?

Answer 5

the idea of using a BIG MAC to illustrate the PPP
using the cost of a Big Mac as the price benchmark, a comparison can then expose how various currencies relate to one another with their buying power

Question 6

Why would you want the exchange rate to go down?

Answer 6

to make our exports more desirable for others

Question 7

According to the PPP, the predicted _________ exchange rate is the one that makes the cost of a Big Mac the _________ in both countries

Answer 7

nominal

same

Question 8

If the predicted exchange rate is more than the actual nominal exchange rate, is the NZD undervalued or overvalued?

Answer 8

undervalued

Question 9

If the predicted exchange rate is more than the actual nominal exchange rate, is the NZD undervalued or overvalued?

Answer 9

overvalued

Question 10

What are three things that contribute to the fact that in the short run, nominal exchange rates are difficult to predict?

1. movements due to __________ price level __________ (and hence anticipated changed in exchange rates)
2. different _______ and ________ influence expectations day to day, making the _________ exchange rate movements more ________ than average goods prices
3. reflect __________ in global ________ for domestic assets - in this case, prices follow average exchange rate movements

Answer 10

1. movements due to current price level differences (and hence anticipated changed in exchange rates)
2. different news and events influence expectations day to day, making the nominal exchange rate movements more volatile than average goods prices
3. reflect fluctuations in global demand for domestic assets - in this case, prices follow average exchange rate movements

Question 11

How and why is the market for loanable funds and the market for foreign currency exchange related?

Answer 11

they are linked by the NCO

• the NCO is part of the LF in a small open economy
• the NCO is involved in the exchange rate

Question 12

The market for loanable funds coordinates _______, _________, and the flow of ________ ________ from abroad (_______ _______ ________)

Answer 12

saving
investment
loanable funds
net capital outflow

Question 13

In an open economy, S =

Answer 13

I + NCO

Question 14

Where does the supply and demand for loanable funds come from?

Answer 14

Supply: national savings (both public and private)
Demand: domestic investment and net capital outflow

Question 15

What are three ways to get loanable funds?

Answer 15

sell a bond and get some loanable funds
issue shares and get loanable funds
they go to a financial institution and get some loanable funds

Question 16

When can loanable funds become a net capital outflow?

Answer 16

Loanable funds in NZ can sometimes go into NZ financial system through bods, share issues and financial intermediaries like banks. But, you can also buy shares overseas and then loanable funds become a net capital outflow

Question 17

The NCO is a potential home for ________ _________ in NZ to exit and go and satisfy investment __________ in Australia

Answer 17

The NCO is a potential home for loanable funds in NZ to exit and go and satisfy investment demand in Australia

Question 18

What are the two homes where savings in NZ could end up in?

Answer 18

in investment in NZ or NCO (finding a home offshore)

Question 19

The purchase of a capital asset by a domestic resident adds to the ________ for loanable funds, regardless of whether the asset is located at home (_______) or abroad (_______)

Answer 19

demand

I
NCO

Question 20

What happens if NCO > 0?

Answer 20

there is a net outflow of capital from NZ which adds to the demand fro domestically generated loanable funds

Question 21

What happens if NCO < 0?

Answer 21

there is a net inflow of capital from NZ which reduces the demand for domestically generated loanable funds

Question 22

The supply and demand for loanable funds depend on the what?

Answer 22

real interest rate

Question 23

What is the effect on the supply and demand for loanable funds and the NCO when the real interest rate increases?

Answer 23

This increases the supply of loanable funds (from investment) and decreases the demand for loanable funds, and reduces the NCO

Question 24

What is on each axis in the market for loanable funds?

Answer 24

On the y axis, there is the real interest rate and on the x axis, there is the quantity of loanable funds

Question 25

What is on each axis on the NCO graph?

Answer 25

On the y axis, there is the real interest rate and on the x axis, there is the NCO

Question 26

What is the effect of an increase in the real interest rate on the NCO?

Answer 26

That is going to discourage outflows because it is less attractive to send funds out of NZ, and encourage inflows because it is more attractive to send funds into NZ (overall lower NCO) * opposite is true for a decrease in real interest rates

Question 27

What is capital flight?

Answer 27

For whatever the interest rate happens to be, the NCO increased because people are bailing from the NZ economy and so you might swap money for another currency.

Question 28

The smaller the country and the more "connected" or open it is to the rest of the world, the more ________ NCO will be

Answer 28

elastic

Question 29

With highly elastic demand (I + NCO), the central bank has limited capacity to influence the __________ interest rate

Answer 29

domestic

Question 30

The CAB is the _______ for dollars and the NCO is the _________ for dollars

Answer 30

demand | supply