Sample Question I EC 750 2009 Fall

Question 1 (a) Debit: Import, Services $ 1,000 Credit: Foreign assets held in US $ 1,000 (increase) (b) Debit: Unilateral transfer $ 500 million Credit: Foreign assets held in US $ 500 million

Question 1 (cont’d) (c) Debit: US assets held abroad $ 100,000 (increase) Credit: Export, Income receipts $ 100,000 (d) Debit: Unilateral transfer $ 3,000 Credit: Foreign assets held in US $ 3,000

Question 1 (cont’d) (c) Debit: Foreign assets held in US $ 4 billion (decrease) Credit: US official reserve assets held abroad (decrease) $ 4 billion (d) Debit: Foreign assets held in US $ 1.5 billion Credit: Foreign assets held in US $ 1.5 billion (increase)

Question 3 (a) An increase in money supply leads to an upward pressure in the price level, which will lead to the currency depreciation. In order to prevent the home currency from depreciating, the central bank intervenes in the FX market by buying home currency with the foreign currency. This action leads to CU  and IR , and as a result BOP .

Question 3 (cont’d) (2) An increase in money supply leads to an upward pressure in the price level. As a result, the home currency depreciates against the foreign currency.

Question 4 (1) The BOJ buys dollars and sells yen. This action leads to an increase in its holding of foreign reserves (IR) and an increase in the currency in circulation (CU). As a result, the monetary base will increase, and so does the money supply.

Question 4 (cont’d) (2) To absorb the increase in the currency circulation, the BOJ will conduct the Open market sale by selling the gov’t bonds it holds. This action leads to a decrease in CU and a decrease in its holding of gov’t bonds (DC). This is called sterilization. When the FX intervention is fully sterilized, an increase in IR is completely offset by a decrease in DC, so that there is no change in CU and MB.