The Open Economy Revisited

Question 1

Key assumption is that

Answer 1

r=r* otherwise everyone will put their money into NZ as they
can control the world’s interest rate

Question 2

Now AD also includes NX(e) but investment will not change – so only variable is

Answer 2

real
exchange rate

Question 3

Money supply does not include the _____ so increasing _____ will have no effect on the exchange rate – so it is perfectly _____

Answer 3

exchange rate, money
supply, inelastic

Question 4

increasing money
supply will have no effect on the ______. so it is perfectly _____

Answer 4

exchange rate, inelastic

Question 5

You can lower the OCR to increase the ______

Answer 5

money supply

Question 6

Increase in OCR will shift the ___ to the right creating _____and so the exchange rate will fall increasing the ____.

Answer 6

LM, excess supply of currency, NX

Question 7

If there is a fiscal policy to increase government spending

Answer 7

this will shift the IS curve
to the right – but will not change Y as exchange rate will be higher so NX will fall

Question 8

An expansionary monetary policy means that aggregate world demand does not _____ – consumers switch from ________ – so it is at the expense
of the abroad _____

Answer 8

Increase, foreign to domestic goods, output

Question 9

If a trade policy is introduced to put tariffs on imports

Answer 9

– this will mean that the IS
curve will shift to the right – but Y will not increase unless the reserve bank
cooperates to increase money supply – and so this will just lead to higher exchange
rate

Question 10

Fixed exchange rate

Answer 10

when you change money supply in order to keep the exchange
rate at a certain level

Question 11

So, if government spending increases IS will shift right

Answer 11

but LM will also shift right to
maintain the exchange rate – this can mean that Y will increase

Question 12

Fixed exchange rate makes monetary policy totally ineffective

Answer 12

as it has to
constantly adjust to maintain the exchange rate

Question 13

If the world interest rises this will lower the investment

Answer 13

this will lead to a
depreciation of the exchange rate as IS shifts left

Question 14

In the China/USA Trade War the TFP declines because you are not using the
cheapest inputs – and this means that Y falls due to fall in A in AKaL1-a

Answer 14

and this would
mean that world interest will increase

Question 15

In the long run we will always come back to

Answer 15

YBAR

Question 16

Ø If the reserve bank changes the OCR to increase money supply – this will put

Answer 16

Y > YBAR

Question 17

Y > YBAR

Answer 17

will mean that prices will rise – this will lower real money supply – which will
lower the real money demand – causing the LM to shift back to the original

Question 18

Can the reserve bank affect the NX and exchange rate by changing the OCR?

Answer 18

short
run yes – long run no

Question 19

There is a country risk

Answer 19

– that borrowers will default due to political/economic turmoil – lenders require higher interest to compensate risk

Question 20

Expected exchange rate changes – if the exchange rate falls then borrowers will have
to pay

Answer 20

higher interest to compensate for the fall

Question 21

r = r* + θ

Answer 21

which represents the risk premium

Question 22

Y =

Answer 22

C + I (r* + θ) + G
+ NX

Question 23

M/P=

Answer 23

=L (r* + θ, Y)

Question 24

If theta increases this will mean that

Answer 24

interest rates rise so investment falls – and
IS will shift the left

so money demand falls and LM will shift the right

Question 25

Deriving the AD curve

Answer 25

we use the real exchange rate instead of nominal as
before we assumed prices are constant – now they are variable