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Michigan EC 302 – Suppose that dollar and euro 1-month

Suppose that dollar and euro 1-month interest rates are equal at 5%. The current spot rate is 1$/e. What is the one month forward rate according to the covered interest parity ? A) 1$/eB) 0.95$/e C) 1.05$/e D) None of the aboveSuppose the dollar-euro spot rate closed yesterday at 1 $/e. The economy was in a long-run equilibrium where PPP holds. Eurozone and US interest rates are equal at 7%. Inflation in the euro area is 2%. Inflation in the U.S. had also been 2%, but news today predicts next years inflation will be 4%. Assume that PPP holds (only) in the long run (one year from today), what will be the market’s expected exchange rate one-year from today? A) 1 $/eB) 1.02 $/e C) 1.04 $/e D) 0.96 $/eContinue from the previous question. Assume that UIP holds. What will today’s spot rate be after the news about inflation assuming no changes in interest rates? A) 1 $/eB) 1.02 $/e C) 1.04 $/e D) 0.96 $/eContinue from the question 2. Now assume that the Fed raises interest rates in response to inflation. That is, for every percentage point of inflation over 2%, the Fed raises interest rates by 1.5%. What will today’s spot rate be (assume that expected inflation remains at 4%). A) 0.99 $/e B) 1 $/e C) 1.02 $/e D) 1.04 $/eFrom the previous question, what is the short-run relationship between inflation and the nominal exchange rate when Fed policy is factored in:1A) Higher inflation leads to depreciationB) Ambiguous relationship-it depends on extend of the Fed’s responseC) Higher inflation leads to appreciationConsider a country that has inflation of 10 percent per year. Real output growth is 2 percent. If velocity of money is constant, what is the money supply growth rate? A) 2% B) 8% C) 10% D) 12%Continue from the previous question. If PPP holds, what is the sign (appreciation vs. deprecia- tion) and the magnitude of the change in the nominal exchange rate? (assume the foreign country has 0 inflation). A) Nominal depreciation by 12% B) Nominal depreciation by 10% C) Nominal appreciation by 12% D) Nominal appreciation by 10%Continue from the question 5. If the nominal exchange rate were pegged, what would be the sign and magnitude of the change in the real exchange rate? A) Nominal depreciation by 12% B) Nominal depreciation by 10% C) Nominal appreciation by 12% D) Nominal appreciation by 10%Consider the game between the central bank and fiscal authority. Suppose a government wanted the central bank to pursue both price stability and full employment output. What should the mandate of the central bank be? A) The “hard” type B) The “soft” type C) Adjusting between “hard” and “soft” depending on the fiscal situation of the government. D) None of the aboveIf the European Central Bank buys Greek bonds and does not sell any other assets, this will tend to raise euro-zone inflation. A) True B) FalseA banking crisis and a currency crisis often happen together because A) productivity growth requires a real appreciationB) a banking crisis typical occurs when inflation is high C) a peg prevents the central bank from printing money as lender of last resort

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