5. The following graph assumes that the 1-year interest rates are equal to 4% in both countries (R = R* = 4%) and the USD/EUR rate is expected to be 1.20. а. What does the downward sloping curve stand for? b. If the exchange rate is Ee, which between domestic assets and foreign assets will be preferred? What would happen to the exchange rate? с. What is the equilibrium exchange rate? Calculate it based on the above information.
5. The following graph assumes that the 1-year interest rates are equal to 4% in both countries (R = R* = 4%) and the USD/EUR rate is expected to be 1.20. а. What does the downward sloping curve stand for? b. If the exchange rate is Ee, which between domestic assets and foreign assets will be preferred? What would happen to the exchange rate? с. What is the equilibrium exchange rate? Calculate it based on the above information.
Brief Principles of Macroeconomics (MindTap Course List)
8th Edition
ISBN:9781337091985
Author:N. Gregory Mankiw
Publisher:N. Gregory Mankiw
Chapter13: Open-economy Macroeconomics: Basic Concepts
Section: Chapter Questions
Problem 6PA
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Transcribed Image Text:5. The following graph assumes that the 1-year interest rates are equal to 4% in both countries
(R = R* = 4%) and the USD/EUR rate is expected to be 1.20.
а.
What does the downward sloping curve stand for?
b. If the exchange rate is Ee, which between domestic assets and foreign assets will be
preferred? What would happen to the exchange rate?
с.
What is the equilibrium exchange rate? Calculate it based on the above information.
d. Suppose that the domestic interest rate declines to 3%. Calculate the new equilibrium
exchange rate. Show the change in the graph and mark the new equilibrium as “4."
e. Suppose that both the domestic and foreign interest rates decline to 3%. Calculate the
new equilibrium exchange rate. Show the change in the graph and mark the new
equilibrium as “5."
Exchange rate,
Egie
Return on
dollar deposits
Expected return
on euro deposits
Rs
Rates of return
(in dollar terms)
2.
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