Question

Over the last 10​ years, the dollar has depreciated sharply​ vis-à-vis the euro. Suppose that in the short run the Fed wanted both to defend the dollar​ (that is, stop its decline​ and/or cause it to​ appreciate) and stimulate investment.

Can it achieve both of these goals simultaneously through monetary​ policy?  

A.

​Yes, to stimulate investment the Fed will use expansionary policy that will raise interest rates. The higher interest rates will reduce investment into the United​ States, which will decrease the demand for dollars and cause an appreciation of the dollar.

B.

​No, to stimulate investment the Fed will use expansionary policy that will lower interest rates. The lower interest​ rates, however, will reduce investment into the United​ States, which will increase the supply of dollars and cause a depreciation of the dollar.

C.

​No, to stimulate investment the Fed will use expansionary policy that will raise interest rates. The higher interest​ rates, however, will reduce investment into the United​ States, which will increase the demand for dollars and cause a depreciation of the dollar.

D.

​Yes, the policy tools needed to stabilize the currency are not related to the policy tools that are used to stimulate investment.

Suppose instead that the European Central Bank​ (ECB) conducts expansionary monetary policy.

What is the​ short-run effect, if​ any, of this policy on the​ euro/dollar nominal exchange rate and on the real exchange rate between the United States and the European Monetary​ Union?

A.

The nominal dollars per euro exchange rate will decrease and the real exchange rate will decrease as long as inflation in the European Monetary Union is higher than inflation in the United States.

B.

The nominal dollars per euro exchange rate will increase and the real exchange rate will increase as long as inflation in the European Monetary Union is higher than inflation in the United States.

C.

The nominal dollars per euro exchange rate will decrease and the real exchange rate will decrease as long as inflation in the European Monetary Union is not significantly higher than inflation in the United States.

D.

The nominal dollars per euro exchange rate will increase and the real exchange rate will increase as long as there is no inflation in either country.

Answer 1

a) "B"

​No, to stimulate investment the Fed will use expansionary policy that will lower interest rates. The lower interest​ rates, however, will reduce investment into the United​ States, which will increase the supply of dollars and cause a depreciation of the dollar.

b) "C"

The nominal dollars per euro exchange rate will decrease and the real exchange rate will decrease as long as inflation in the European Monetary Union is not significantly higher than inflation in the United States.