Questions and Problems (Chapter 6)

1. Explain how the central bank fixes the exchange rate

2. What is the policy of sterilization? Give an example
3. Explain why in practice the extent to which a measured balance of payments disparity,
either a surplus or a deficit, will have an uncertain effect on home money supplies?
4. If the central bank does not purchase foreign assets when output increases but instead holds

the money stock constant, can it still keep the exchange rate fixed at E0?
5. Explain why under fixed exchange rate, monetary policy is ineffective whereas under
floating exchange rate it is effective in rising output.
6. Explain why a permanent fiscal expansion has no effect on output under a flexible
exchange rate, but it is effective under a fixed exchange rate.
7. Discuss the different effects of a temporary fiscal expansion under the fixed and flexible
exchange rate
8. Discuss the effect of a devaluation on the current account balance
9. What is the asset imperfect substitutability? Explain why the interest parity condition
(R=R*+(Ee-E)/E) does not hold under the assumption of imperfect asset substitutability.
10. Explain why a sterilized intervention can affect the exchange rate when domestic and foreign
assets are imperfect substitutes.
11. A change in market belief with regards to the fixed exchange rate could lead to currency
crises. Explain this statement.