For the following questions, answer True (T), False (F) or Uncertain (U). Please briefly explain your answer.
1. Exchange rate overshooting explains why permanent government spending increases are less effective in increasing output than temporary increases.
2. Bretton Woods failed because the U.S. abused its position as the reserve currency country.
3. A central bank's inflation target affects the country's exchange rate.
4. A gold (exchange) standard introduces short-term and long-term price stability.
5. The creation of the EMU has led to greater restrictions on both monetary and fiscal policy on the part of its member countries.
6. An increase in the European Union money supply has no impact on the Canadian economy.
1.Exchange rate overshooting explains why permanent government spending increases are less effective in increasing output than temporary increases.
The phenomenon of exchange rate overshooting is because of permanent increase in money supply and not on government spending.
Exchange rate overshooting is because of stickiness of the prices in the short run and occurs when there is a permanent increase in money supply. Since the prices are sticky in the short run an increase in the money supply increases the real money supply and lowers the domestic interest rate. Since the domestic interest rate is lowered the domestic currency depreciates. This depreciation is more than the long run equilibrium exchange rate. This phenomenon is called overshooting. The currency then appreciates from this level to reach the long run equilibrium level as the prices start to increase in the long run and the interest rate returns back to the level before there was an increase in money supply. (Money supply is neutral in its effect on long run value of the interest rate or real output.)
2.Bretton Woods failed because the U.S. abused its position as the reserve currency country.
Bretton Woods established a reserve currency where the US dollar was the reserve currency. In the reserve currency system each ...
Solution discusses 6 TRUE/FALSE questions on exchange rate.