Econ 402, Winter 2017
Lecture 19 review questions
1. One USD bought 26 Russian rubles in March 2007 and 56 Russian rubles in March 2017.
Calculate the annual appreciation rate of USD against the Russian ruble. Assuming interest
rate parity (IRP) holds, what should be the average difference in risk-adjusted nominal interests
between the two countries?
2. Suppose that a foreign country has restrictions on capital flows to/from abroad. Which
approach would be more appropriate for forecasting this country’s future exchange rate:
purchasing power parity (PPP) or IRP? Explain your reasoning.
3. What are some of the reasons for a small open economy to pursue a fixed exchange rate policy
with the US dollar? Give examples.
4. Currently, 10-year US Treasury bonds pay an annual interest rate of 1%, 10-year bonds of the
State of New Jersey pay 2.5%, and 10-year bonds of the State of Illinois pay 3.5%. How do
you explain this difference through interest rate parity? Assuming that US Treasury bonds are
safe (0% chance of default), can you estimate the chances of default within a year in Illinois
and in New Jersey?
5. What are the endogenous variables in the Fleming-Mundell model when prices are fixed in the
6. Why is the ? line in the Fleming-Mundell model vertical rather than upward-sloping? 7. In the Fleming-Mundell model, the ? line relates which two endogenous variables? 8. Suppose that the government is considering putting a restriction on flows of capital in/out of
the country. Then, after the policy is implemented, the interest rate will _____ if the country’s
current account is _____. Draw a diagram illustrating your reasoning.
a) rise, positive
b) fall, positive
c) fall, negative
9. How is the equilibrium real exchange rate determined in an open economy with restricted
capital flows? How is the equilibrium interest rate determined an open economy with restricted
capital flows? Draw diagrams showing your reasoning.
10. According to the Fleming-Mundell model, what is the relation between government
expenditure and nominal exchange rate in the short run? Draw a diagram to illustrate your
11. Consider a small open economy described by the Fleming-Mundell model. Suppose that the
government pursues a fixed exchange rate policy. How can this policy be implemented with
changes in money supply? Draw a diagram showing how money supply is determined under
fixed nominal exchange rate regime. 12. Would a fixed exchange rate regime make sense for the US? Why or why not? Explain. Page 1 of 1