1. If a country under a fixed exchange rate regime finds that its currency is overvalued, i.e., the official fixed rate is above the fundamental market value of its currency, what action must it undertake to prevent its currency from depreciating? Use the graphical model of short run exchange rate behavior to explain the effects of this action. Why may a country be unwilling or unable to enact such a policy?

2. If at its next policy meeting the FOMC decreases its target federal funds rate,
(a) describe the open market operations the Fed would enact to achieve a lower federal funds rate. Explain briefly, and show graphically the effects of these open market operations on the federal funds rate.
(b) Briefly explain what the Fed would be trying to achieve with a lower target rate and how the actions that bring about the lower federal funds rate will help to achieve this objective.
(c) Explain the effect this policy action is likely to have on the exchange rate of the U.S. Dollar.

3. Assume the bailout of the U.S Auto industry works, and the world’s car buyers begin to prefer American cars to those of other countries. Explain carefully the effect this change in consumer preferences will likely have on the long run pattern of the exchange rate of the U.S. Dollar.

4. China’s currency has been pegged to the U.S. Dollar (with minor upward adjustments over the past few years). It has been suggested that, in this fixed exchange rate system, the Chinese currency has been undervalued, i.e., the fixed rate less than its fundamental market value. Why might China want to undervalue its currency? If it is undervalued, what foreign exchange intervention must be undertaken by the central bank of China to keep its currency from appreciating significantly? Explain and show graphically. Also briefly note the likely effect on the domestic Chinese economy resulting from this intervention by the central bank. (Explain these effects assuming capital markets in China were open.)

5. In the late 1990s Thailand found that its currency, the Baht, was overvalued. That is, its fundamental market value was being pushed below its stated par value. What foreign exchange intervention was required by the Thai monetary authorities to prevent its currency from falling in value? Explain the effects of this policy on the value of the Baht. Also summarize the likely effects on the Thai economy. (Use the graphical model of the short run behavior of exchange rates to show the effects of this intervention.) Why was this effort eventually unsuccessful, inducing the Thai government to abandon its fixed exchange rate regime?

7. If the U.S. imposes restriction (e.g. tariffs) on imported goods, what will be the likely long-run effect on the exchange rate of the U.S. Dollar? Explain carefully. If the Fed begins to raise short-term interest rates later this year, what will be the likely effect on the exchange rate of the Dollar? Use graphical model of exchange rates to explain the response.

1. If a country under a fixed exchange rate regime finds that its c...