1. Suppose that a Fiat costs €30,000 in Italy and that the current USD/EUR exchange rate is .90.
a) Calculate the dollar price of the Fiat.
b) Now suppose the euro appreciates relative to the dollar by 2%. What is the new
USD/EUR exchange rate? What is the new dollar price of a Fiat?
c) Now suppose Fiat knows that a price increase in the U.S. market will cost them a
significant market share, and subsequent profits. Thus, they choose to adopt an exchange
rate pass through scheme such that they absorb 75% of the exchange rate change
internally. Now what would be the dollar price of a Fiat faced by U.S. importers?
2. If Germany is running a trade surplus, what must be true of its capital flows on net (Savings
versus Investment)? How do you know? How would the German government running a budget
deficit impact the initial current account surplus? Illustrate and explain.
3. What do we mean by interest rate parity? Explain the process by which we get convergence in
equilibrium in the foreign exchange market towards this outcome if the foreign rate of return is
initially higher than the domestic rate of return.
4. Show the effects of expansionary fiscal policy (e.g. an increase in government expenditure) on
our simultaneous equilibrium in the money and foreign exchange markets. How does the shock
originate? What is the ultimate impact on the value of the domestic currency?
5. Show and describe the effects in US asset markets of the European Central Bank (ECB)
implementing expansionary monetary policy in response to a recession. What are the effects on
simultaneous equilibrium in the money and foreign exchange markets from the US’ perspective?
How does the ECB create the change in the European money market? What happens to the rates
of return on deposits? What is the ultimate impact on the USD/EUR exchange rate?
6. The policy scenario described in question 5 is a response to short-run fluctuations. Does that
result match up with the long-run response of e? Illustrate and describe the ultimate long-run
response of the exchange rate to such a policy. Is there a disconnect between the classical longrun concept of the Quantity Theory of Money and the ultimate change? Why or why not?
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