ECON6008 S1 2023 Tutorial 3
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ECON6008 S1 2023
Tutorial 3
1. The graph on the right depicts real money supply. Draw the aggregate money demand curve in the diagram to the
right. Label this line
'L(R,Y)1 '.
Now, suppose that real GNP rises. On the same graph, draw the new aggregate real money demand. Label this line 'L(R,Y)2 '.
As the result of a rise in real GNP, equilibrium in the money market will be at a (1) interest rate. Real money holdings will (2) .
|
|
(2) |
|
remain unchanged rise fall |
Interest rate, R
MS
Real money holdings
2. Consider the simultaneous equilibrium in the US money market and the foreign exchange market. In this problem we will analyze the effect of a decline in the future expected exchange rate (expected 
E$ / e
), i.e. expected dollar appreciation.
The figure on the right shows the return on dollar deposits as a function of the dollar/euro exchange rate 
E$ / e
.
1) Draw the line representing the dollar return on euro deposits.
2) Draw a new line on the same graph representing the dollar return on euro deposits as the future expected exchange rate falls.
As the result of a decline in the future expected exchange
rate, the dollar will (1) today.
Exchange rate
return
Rates of return
(1) appreciate depreciate
3. Consider the simultaneous equilibrium in the US money market and the foreign exchange market. In this problem we will analyze exchange rate overshooting as a response to a permanent increase in the US nominal money supply.
Assume that, in the short-run, prices are completely fixed and that they fully adjust in the long-run. Assume throughout the problem that real GNP remains unchanged.
Start with the money market equilibrium. As the result of
an increase in the nominal money supply, the interest rate will (fall/rise?) in the short-run.
In the long-run, prices will fully adjust—they will
increase proportionally to the change in the nominal money supply. Therefore, in the long-run the interest rate will be
A. equal to the new short-run interest rate.
B. between the initial interest rate and a new short-run in
C. lower than the new short-run interest rate.
D. equal to the initial interest rate.
The figure on the right shows two lines for the expected return on euro deposits and two lines for the return on dollar deposits as a function of the dollar/euro exchange rate (E$ / e ).
1) Indicate the initial equilibrium (before any changes occur) and label it "Initial."
2) Next, indicate a short-run
equilibrium (after the increase in the nominal money supply but before the prices adjusted) and label it "Short-run."
3) Finally, indicate a new long-run equilibrium point (after prices fully adjusted) and label it "Long-run."
Exchange rate overshooting occurs, as you can see from the graph, because in the short-run the exchange rate rises by more than it rises from the initial to the long-run level.
Dollar return
After Before
After
Before
Expected return on euro deposits
Rates of return
4. Suppose there is a permanent reduction in aggregate real money demand, that is, a negative shift in the aggregate real money demand function. Trace the short-run and long-run effects on the exchange rate, interest rate, and price level.
A. In the short run, the interest rate will rise, the expected return on foreign currency will decrease, which results in an appreciation of the domestic currency. In the long run, the price level will fall to equate money demand with money supply at the initial (long run) interest rate.
B. In the short run, the interest rate will fall, the expected return on foreign currency will increase, which results in a depreciation of the domestic currency. In the long run, the price level will rise to equate money demand with money supply at the initial (long run) interest rate.
C. In the short run, the interest rate will fall, the expected return on foreign currency will increase, which results in a depreciation of the domestic currency. In the long run, the price level will rise to equate money demand with money supply at the lower interest rate.
D. In the short run, the interest rate will rise, the expected return on foreign currency will decrease, which results in an appreciation of the domestic currency. In the long run, the price level will fall to equate money demand with money supply at the higher interest rate.
In the long run, the exchange rate will
A. continue to depreciate as the interest rate returns to its long-run value.
B. continue to depreciate as the interest rate moves to its new lower long-run value.
C. depreciate some as the interest rate returns to its long-run value but will appreciate relative to its initial value.
D. appreciate some as the interest rate returns to its long-run value but will depreciate relative to its initial value.
5. In our discussion of short-run exchange rate overshooting, we assumed that real output was given. Assume instead that an increase in the money supply raises real output in the short run (an assumption that will be justified in Week 5 lecture). How does this affect the extent to which the exchange rate overshoots when the money supply first increases? Is it likely that the exchange rate undershoots?
2023-05-29