T8 Optimum currency areas.The Economic and Monetary Union(Chapter 14)

Question 1

Two important principles

Answer 1

The interest rate parity condition and purchasing power parity

Question 2

only one thing is traded on market for goods and services and fin ancial market

Answer 2

the good with price P and the bond with with ir

Question 3

the main aim is to

Answer 3

determain how their work independently and interact

Question 4

partial equilibrium

Answer 4

separated equalibrium of both markets

Question 5

general equilibrium

Answer 5

equilibrium of both markets simultaneously

Question 6

in macroeconomic the good

Answer 6

is the country GDP

Question 7

y=

Answer 7

Y=C+I+G

Question 8

Why when the interest rate is higher firms invest less?

Answer 8

because they borrow less

Question 9

there is a negative effect of equilibrium (caused by increased of ir)

Answer 9

of the interest on equilibrium GDP

Question 10

Why economy is always at its IS curve?

Question 11

A trader deciding on investing anywhere in the world

Answer 11

Compares interest rates;
- Considers exchange rate fluctuations: if foreign currency
appreciates, an investment abroad will also lead to capital gain.

Question 12

Does the interest rate parity condition work?

Answer 12

Interest parity condition interpreted as revealing market expectations:
Expected exchange change rate depreciation = Domestic interest rate
- Foreign interest rate
.
But on top of exchange rate fluctuations there is also risk:
Interest rate of risky asset = Interest rate of safe asset + Risk premium

Question 13

Three principles (2): purchasing power parity

Question 14

Flexible exchange rate:

Answer 14

Currencies continuously priced by (foreign)
exchange markets

Question 15

Fixed exchange rate:

Answer 15

Government keeps exchange rate fixed through
reserves and buying and selling currency

Question 16

Assuming free movement of capital

Answer 16

monetary policy is deeply
affected by exchange rate regime

Question 17

The impossible trinity principle is central to European integration:

Answer 17

fixing the exchange rate means adopting the foreign interest
rate; conversely, maintaining the ability to choose the domestic
interest rate requires allowing the exchange rate to float freely.

Question 18

One way of escaping the choice between exchange rate stability and
monetary policy autonomy is to restrict capital movements.

Answer 18

Many European countries operated extensive capital controls
until the early 1990s
– Many of the new EU members only abandoned capital controls
upon accession.

Question 19

Since the EU adopted in 1992 the principle of open capital
markets,

Answer 19

the choice has been circumscribed to the left or
bottom sides of the triangle.

Question 20

There are examples for each side of the impossibility triangle:
- Full capital mobility and autonomous monetary policy: Eurozone as
a whole, USA, Japan, UK, Switzerland, Sweden:
* Any advantages? And disadvantages? Look at the British and Swiss
cases:

Answer 20

graph

Question 21

Full capital mobility and fixed exchange rates: EU Exchange Rate
Mechanism; Denmark
why

Answer 21

graph,to reduce risk !
The Danish CB shadows the ECB interest rates:

Question 22

Fixed exchange rate and monetary policy autonomy:

Answer 22

many
developing and emerging countries, which establish capital controls
(e.g. see trends of Brazil, China, and Switzerland against the dollar
during the crisis).

Question 23

What happens when one tries to violate the impossible trinity?

Answer 23

A
currency crisis: sooner or later a speculative attack wipes out
the fixed exchange rate arrangement

Question 24

our currency goes up when

Answer 24

inflation abroad is higher than at home

Question 25

When does the exchange rate regime matter?

Question 26

oney neutrality principle
asserts that nomina

Answer 26

nominal variables do not affect real variables in the long
run. PPP implies that the real exchange rate is constant.

Question 27

Free floating of exchange rate:

Answer 27

• Expansion of money supply  falling interest rates 
  capital outflows  currency depreciation

Question 28

Fixed exchange rate regime:

Answer 28

Expansion of money supply  pressure on currency  to
maintain the exchange rate, the Central Bank must sell
reserves to buy back own currency  the money created
is re-absorbed