Econ 3229 Ch 19

When the Fed performs a foreign exchange intervention by buying German government bonds, it increases the demand for euros and decreases the supply of dollars in the foreign exchange market. This leads to a decrease in the value of the dollar relative to the euro, causing the dollar to depreciate.

A sterilized foreign exchange intervention refers to a central bank's action to buy or sell foreign currency in the foreign exchange market while simultaneously offsetting the impact on the domestic money supply. In this case, the intervention would alter the asset side of the central bank's balance sheet by increasing or decreasing its holdings of foreign currency, but it would not affect the domestic monetary base. This means that the central bank is able to influence the exchange rate without causing changes in the money supply or domestic interest rates.

If the bonds of two different countries are identical, their expected returns will be equal if capital flows freely internationally. This is because when capital flows freely, investors can easily move their money between countries to take advantage of higher returns. As a result, the demand for bonds in both countries will be equalized, leading to equal expected returns. However, if capital flows are restricted or there are barriers to international investment, the expected returns may not be equal as investors may not be able to freely access the higher returns available in the other country.

If foreigners are restricted in their ability to buy investments in a country, it means that the government is imposing controls on capital inflows. This means that the government is regulating and limiting the amount of foreign investment that can enter the country.

When the Fed buys euros or sells dollars, it essentially increases the supply of dollars in the banking system. This leads to an increase in reserves in the banking system because banks receive more dollars from the Fed. Therefore, the correct answer is "Buys euros or sells dollars."

When the Fed purchases euros, it effectively increases the supply of euros in the market. This increase in the supply of euros will lead to a decrease in the value of euros relative to dollars. As a result, individuals and businesses will have less demand for dollars and more demand for euros. Therefore, the impact on the foreign exchange market for dollars resulting from the Fed purchasing euros will be a decrease in the demand for dollars.

If capital flows freely between countries and a country has a fixed exchange rate, it means that the country cannot have a domestic monetary policy. This is because a fixed exchange rate requires the country to maintain the value of its currency relative to other currencies. To do this, the country must give up its ability to independently control its monetary policy, such as setting interest rates or printing money. Instead, the country must adjust its monetary policy to match the policies of the country or countries to which its currency is fixed.

To keep the federal funds rate on target, the Open Market desk sold US treasury bonds. Selling US treasury bonds reduces the money supply in the economy, which helps to increase interest rates and keep the federal funds rate in line with the target set by the Federal Reserve. By selling bonds, the Open Market desk is essentially taking money out of circulation, which helps to control inflation and stabilize the economy.

The United States would be characterized as having a controlled domestic interest rate because the Federal Reserve has the authority to set and adjust interest rates to control inflation and stimulate economic growth. It also has an open capital market, meaning that foreign investors can freely invest in US financial markets. Lastly, the US has a flexible exchange rate, which means that the value of the US dollar fluctuates based on market forces such as supply and demand.

We should expect the percentage change in the number of units of country A's currency per unit of country B's currency to be -0.5%. This is because if the inflation rate in country A is higher than in country B, it means that the value of country A's currency is depreciating faster compared to country B's currency. As a result, the number of units of country A's currency needed to exchange for a unit of country B's currency will decrease, leading to a negative percentage change of -0.5%.

International capital mobility refers to the ability of capital to move freely between countries. This allows investors to seek out higher returns on their investments, regardless of where they are located. As a result, capital flows can help equalize expected returns across countries. When there is a higher return on investment in one country, capital will flow into that country, increasing the demand for its currency and causing its exchange rate to appreciate. Conversely, when there is a lower return on investment in a country, capital will flow out, decreasing the demand for its currency and causing its exchange rate to depreciate. Therefore, international capital mobility contributes to the equalization of expected returns across countries.

If the Fed desired to fix the euro/dollar exchange rate, they would have to be willing to exchange dollars for euros whenever anyone asked. This means that the Fed would need to have a sufficient amount of euros in reserve and be ready to exchange them for dollars at the fixed rate whenever there is a demand for it. This would help maintain the fixed exchange rate between the two currencies.

A sterilized foreign exchange intervention refers to a situation where a central bank, in this case the Fed, purchases or sells foreign currency in the foreign exchange market while simultaneously conducting offsetting transactions to neutralize the impact on the domestic money supply. In this scenario, the Fed is purchasing euros for dollars and selling U.S. Treasury securities, which helps to offset the increase in the money supply that would have occurred due to the purchase of euros. This intervention aims to influence the exchange rate without affecting domestic monetary conditions.

This answer is correct because it describes a situation where Mexico is implementing a control on the outflow of its own currency, pesos, by limiting the amount its citizens can take out of the country. This is an example of a capital outflow control because it restricts the movement of capital from Mexico to other countries. The other options do not involve controlling the outflow of capital, but rather the inflow or purchase of foreign currency.

When the Fed decides to maintain a fixed euro/dollar exchange rate and purchases euros, they increase the number of dollars in circulation. This increase in the money supply puts downward pressure on domestic interest rates. Therefore, all of the answers given are correct.

Fixed exchange rates can help establish a credible low inflation policy for a country that suffers from bouts of high inflation. When a country pegs its currency to another currency or a fixed value, it limits the ability of its central bank to print more money or engage in expansionary monetary policies that could lead to inflation. This commitment to maintaining a stable exchange rate can signal to investors and the public that the government is serious about controlling inflation, which can help build confidence in the country's monetary policy and reduce inflation expectations.

A foreign exchange intervention by a central bank affects the value of a country's currency because it alters banking system reserves and changes domestic interest rates. When a central bank intervenes in the foreign exchange market, it buys or sells its own currency to influence its value. This buying or selling of currency affects the banking system reserves, as the central bank either adds or removes currency from the system. Additionally, the central bank's actions can also impact domestic interest rates, as buying or selling currency can affect the supply and demand for money, leading to changes in interest rates.

This statement is incorrect because a country cannot be open to international capital flows, control its domestic interest rate, and fix its exchange rate simultaneously. When a country allows international capital flows, it gives up some control over its domestic interest rate and exchange rate. If it wants to fix its exchange rate, it needs to restrict capital flows and give up control over its interest rate. Therefore, the correct answer is that a country cannot be open to international capital flows, control its domestic interest rate, and fix its exchange rate at the same time.

A fixed exchange rate policy imports monetary policy from other countries. This means that changes in the exchange rate are determined by the central bank's actions in response to changes in the foreign exchange market. Therefore, the domestic interest rate policy is strengthened as it is influenced by the exchange rate policy. Additionally, a fixed exchange rate policy can make domestic inflation more volatile as it limits the ability of the central bank to adjust interest rates to control inflation.

The correct answer is that all of the answers given are correct. This means that if country A wants to fix its exchange rate with country B, its inflation rate will have to match country B's. Additionally, country A's monetary policy must be conducted in a way that ensures the inflation rate in country A matches the inflation rate in country B. Finally, country A's monetary policy will not be able to be used to address domestic issues.

When a country with a fixed exchange rate policy is experiencing an economic slowdown, the stabilization mechanism that policy makers could have used is completely shut down. This means that they are unable to adjust their exchange rate to stimulate their economy. In a fixed exchange rate system, the value of the currency is pegged to another currency or a basket of currencies, and the central bank has to maintain this fixed rate. As a result, the country cannot devalue its currency to make exports more competitive or adjust interest rates to stimulate economic activity. This lack of flexibility can hinder the country's ability to address economic slowdowns effectively.

In a situation where arbitrage occurs across countries with flexible exchange rates and when the bonds in each country are identical with no barriers to capital flows, the interest rates on the bonds will not necessarily be identical. This is because interest rates are influenced by various factors such as inflation, economic conditions, and monetary policies of each country. Similarly, the prices of the bonds will not necessarily be identical as they are determined by supply and demand factors in each country's bond market. Additionally, the inflation rates in each country will not necessarily be identical as inflation is influenced by various domestic factors. Hence, none of the answers provided is correct.