an-investment-analyst-recommended-that-investors-gravitate-toward-the-stronger-currencies-and-countr

Question

An investment analyst recommended that investors "gravitate toward the stronger currencies and countries that are running current-account and fiscal surpluses," such as South Korea and Taiwan.
a. Holding all other factors constant, would we expect a country that is running a government budget surplus to have a currency that is increasing in value or decreasing in value? Briefly explain.
b. Holding all other factors constant, would we expect a country that has a currency that is increasing in value to have an increasing or decreasing current account surplus? Briefly explain.
c. Is the combination of economic characteristics this analyst has identified likely to be commonly found among countries? Briefly explain.

Erwin Antoni · Accepted Answer

if a nation is running a surplus, this very often leads to lower interest rates and those lower interest rates than in turn lead to a depreciating currency. For the second part of this question, if you have an appreciating currency, that is a currency that is gaining in strength, this tends to decrease the current account surplus because net exports will be falling in appreciating currency means you&#x27;ll be importing Maurin exporting less For the third part, the historical data that we have doesn&#x27;t very frequently match the idea of the twin deficits or twin surpluses. While there is evidence that there was a twin deficit in the United States in the early in mid 19 eighties, most of the other time periods during which the data is available, this does not seem to be the case.

Alex Loukas · Answer

Hi, everyone. Today we&#x27;re starting chapter 34 with question one where we&#x27;re being asked to explain how each of the following developments would affect the supply of money, the demand for money and the interest rate. And we should illustrate our answers with diagrams. All right, so first of all, we don&#x27;t determine what is the right kind of background we&#x27;re gonna be using. Since our questions deal with a money market, it makes sense to use a simple supply and demand graph for the money market. Namely on the X axis. We have a quantity of money. Em on the Y axis. We have interest rates. Are the money supply curve will always be very cool because it&#x27;s fixed by the central bank exogenous Lee and the money demand curve will be downward. Sloping. Now, just a quick reminder. Why&#x27;s the money Domenic Irv downward sloping according to the theory of requested preference that we&#x27;d learned in chapter 34 the interest rate is the opportunity cost of holding money that is one. You hold wealth as cash in your wallet instead of as an interest bearing bonds he&#x27;d lose dangerous. You could have earned as a result and increasing the interest rate raises the cost of holding money and consequently reduces according to find demanded and vice versa. So we see there is a negative relation between the interest on the interest rates in money holdings, and hence the card will be Dad would stuff. All right, So part of one asks what happens when the feds bond traders buy bonds and open open market operations? Well, this is not a very difficult question, because we know that when the feds bond traders buy bonds, they increase the supply of money in the economy. So the money supply curve will move from M s one m iss to those shift to the right. And since this die, sex and downward sloping on domenica of Lower Point, are you a liberal interest rate would be lower women from our warrant, Artoo. And of course, this makes sense. Since the buying of bonds in open market operations in checks minded the economy, money becomes more abundant, and hence the interest they&#x27;re going to be baring must be lower. Okay, Part B asks what happens when an increasing credit card availability reduces the amount of cash. People want hope This is even more straightforward because we&#x27;ve been given that people want to hold less money. So what does this mean? That the demand for money decreases. So the one demanded Carver will shift to the left MD one coast of empty, too. And hence, once again, the equilibrium interest is gonna drop from our warn. You are too parte si says what happens when the Federal Reserve reduces bank&#x27;s reserve re part mints? Okay, well, let&#x27;s think about it for a second. One of the many tools of the Fed is changing or setting the targets for the banks with the minimum banksreserve requirements. So if the feds says that now that banks needs to have 10% instead of 20% in reserve requirements, one of the bags going to do, you&#x27;re going to be able to lend more money. Yeah, through loans. And this will definitely increase the one supply. So the months of, like her ships from M. S one m isu and once again think a liberal interest rate reduces toward two. This is very similar to, ah, to our first case party. All right, Part four says how scolds decide to hold more money to use for holiday shopping once again. Here it is. The answer is very straightforward, because we&#x27;ve been given that households want more money, so we know that the money Domenica will sift to the right from MD one empty too. And since money becomes more wanted in this economy, think about it as a more scars commodity. The interest the interest interest rate will have to increase from our one part two. Finally, we&#x27;re being asked to determine what happens when a wave of optimism boosting but business investment and expands angry demand once again similar to party. What&#x27;s happening here is that business become very optimistic about the future they wanted. Invest more than I want to take more loans, and this will increase the demand for money since agreement expense. So the money demand Carvel shift from MD want empty, too. And once again, since money Demet money because I become the more scars commodity more one calamity in the economy, the interest rate will rise from our want art, too

Erwin Antoni · Answer

So if we think the Fed is going to be keeping rates low as in as investors, than we&#x27;re going to assume that there&#x27;s going to be some inflation coming in the future. The reason for this is because the way the Fed fights inflation is by increasing interest rates. What that does is it limits the quantity of money and that keeps the dollar&#x27;s value stable. But if they&#x27;re not going to raise interest rates, if they&#x27;re going to keep rates low, then that&#x27;s going toe. Probably cause inflation. Now, for the second part here, we&#x27;re talking about strengthening the dollar. What exactly does that mean? Well, basically, it means that we&#x27;re making sure the dollar keeps its value over time, were keeping it strong, is the terminology. So what does that mean in terms of inflation, while inflation is the dollar not keeping its value over time, so a strong dollar necessarily means less or no inflation?

Alex Loukas · Answer

moving on to question two. We&#x27;re being given that the Federal Reserve expands the money supply by 5% and party winning to use the theory of liquidity preference to illustrate in a graph the impact of this policy on the interest rate well falling from question one. We know that the theory of liquid the preference Khun B. Illustrated very vividly using the supply and demand Graff in the money markets on the XX. What have the point of money m on the Y axis who have interest? They are the money, the man curve will be downward sloping and there&#x27;s always the months of lack of will be vertical because it&#x27;s fixed by the central bank here. Since the Fed expands the money supply by 5% this means that we have a rightward shift. The money supply curve from M s one em is to and as a result, the initial interest rates are one will decline and reach are too right here. All right, in part B, we need to use the model factory demand and I greet supply to illustrate the impact of this change in the interest rate in back of the change in the interest rate on output and the price level in the short run. All right, well, we know how to do that. We&#x27;ll use the standard. Agreed to play angry demand graph on the XX. We have the quantity about. But why? On the y axis, we have the price level team as always, the long grand a great city like it will be vertical and intersects the exacts that the natural level thought with white one and the economy now is initially operates at the algorithm anchor of 81 on the aggressive spiker eh s one. So the economy&#x27;s initially at point A. Now, since the Fed expanse and money supply and the equilibrium straight will decline. And as a result, how&#x27;s worlds will increase their spending and invest more in new consumption goods maybe invest in durable goods and or maybe even new housing. And on top of that, firms will also increase their investment spending. So, as a result, the agri demand from shift to the right and we go right here from 81 82. The ignorant supply crew is unaffected in the short run. So they caught the economy will operate at the new point B. And what is that was that means this means that we have a short in fluctuation. The results of the higher level felt with white too. So the difference between why one y two is thie expansionary gas? The economy is experiencing a boot on foreign. Be all right, Port CIA asks one. The economy makes a transition from a short ironically room to its new longer and equilibrium. What would happen to the price level? Also, when I forgot to mention that point beat not only the the output expands most the price level increases from people on the B two, but now, over time when the economy is moving to its new longer and equilibrium, what&#x27;s happening along the transition path to the new longer equilibrium as the expected price level adjusts the expected one? Remember, the short run aggregates of liquor will also just because producers will adjust the production plants according clean. And so the aggregates of the shorter *** supply Kirm will shift to the left from A s want to Ieyasu. So now the economy&#x27;s Baggett Point C, which corresponds to the natural level folk with Y one, and the prize level will increase. Even more were p three, which is Wei Wei higher than when we started with people on and part four party follows and says, What would what will this change? How will this change? In the price? I will affect the demand for money and the equilibrium interest rates the once again right here in the bottom left. We need to resort to a standard money market graph. I have recreated the graph from party, eh? But now we know that the increase in the price level will cause an increase in the demand for money. Right? Everything costs more so people needed more money to pay for the for consumption investment. So the demand from UN increases from 81 to MD want empty too. And the ICC liberal interest rate will increase and go back to it&#x27;s our one, which is the natural rate of interest. So what is happening here is that price level just once again, equilibrium interest rate goes up and this is what is actually causing the ship of the output, the fall, and go back. Where is Logan level? And finally, party asks, Is this analysis consistent with the proposition that money has really effects in the short run, but it&#x27;s neutral in the long run. So is there no, it&#x27;s considered with theory. Yes, we just illustrated how this works. We showed that while output initially rises because of the increase in aggregate demand over time, we were full ones. Ashore drawn, Hagrid, supply curve, adjust according thing. So indeed, there are shortened money has really short of effects and real output over the longer, and money is mutual.

Yi Chun Lin · Answer

Okay. Question three. The problem Off time inconsistency flies to fiscal policy as well as to monetary policy. Suppose the government announced a reduction in Texas and income from Pebble investors like new factories. So was Rene. If investors believe that Carol Texas would remain Whoa, how would a government section victor level of investment? So if off investors believe that Texas will remain low so they will invest more, apparently. So this investment goes up. You see question be after investors have responded to the investment off tax reduction with just when investors increase their investments, Does the government have an incentive to revenge on his policy? Well, yes, of course, if everyone is, um, investing war. The government would like to text more on those investors. So the government would just bail on what they said, and they would just say, Oh, sorry. I think today the policy should be rising. Texas. So question. See, even your answer. So, given the insert in question be which is that the government will not stick to the plane stick to their announcement. Would investors believe the government&#x27;s announcement? No, they will not believe. And what can we do to increase the crabby we off announced policy changes. So to increase the credibility off announced policy changes, they can, maybe like, permite provide more reasons why they need to raise taxes this for now. Maybe they can see that. Uh, do dio, um, restrictions on foreign investors we find, like, like more and more foreign investors are, like, sneakily investing our country, so Ah, we yearn said, announced that we have to change our policy or something like that. At least provide some reasons that you has that the, um you have the right, um, situation to make this policy to, um, enforce this new policy. Okay, question d explain why this situation is similar to the time inconsistency problem faced by Margie policy makers. So here, for example, I say monetary policy makers are king to control inflation. So they might say that old Marlon interest rates going to rice so people save that was a invest and then is like in this example is so as people are really investing are really saving their money in the bank, the sun, we say that we actually do not need that high oven interest rate to control our inflation. We can just lower it a little bit. So that is, in our example of why time inconsistency. And they change government&#x27;s policy because every announcement would readjust, um, consumers or investors believe about a future. So one day, just their behavior accordingly. In the from macro perspective, their aggregate behavior is going to change macro economy as a whole. So that is why the government has to readjust their policy according to people&#x27;s behavior.

Erwin Antoni · Answer

Charles Schwab brings up a very serious issue, and that is that one of the consequences of the Federal Reserve&#x27;s low interest rate policy was that an entire generation of Americans thes retired seniors lost a tremendous amount of purchasing power because they lost a tremendous amount of income through these low interest rates. So the higher rates would have meant that there would be more income for seniors, and those seniors could then spend more. So we should see higher consumer spending levels now. The higher rates would have also decreased investment spending. So therefore, from those two facts, we can conclude that the Fed believed that the multiplier from investment spending was greater than the multiplier from consumption spending.

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According to an article in the Economist, "countr…

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Glenn Hubbard, Tony O'Brien

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