ECS2602 ASSIGNMENT 3 SEMESTER 1 & 2 2021
With Explanations
For Assistance: Call +27 61 844 1387
1. OPTION 2 Reference: Study Guide PG 145
The correct option is 2. According to the interest-parity relation a higher domestic interest rate leads
2. OPTION 2 to an appreciation of the nominal exchange rate (i↑ → E↑). The opposite will also be true (i↓ → E↓).
3. OPTION 5 In the above example, the interest parity condition holds which means that the domestic interest rate
approximately equals the foreign interest rate minus the expected rate of appreciation of the
domestic currency. But what happens if, for some reason, the domestic interest rate increases to
10%? At a domestic interest rate of 10%, given that the nominal exchange rate is R1 = $0.20, the
interest parity condition no longer holds since the expected rate of return on domestic bonds is
greater than that of foreign bonds. For interest parity to be re-established, the current exchange rate
will have to appreciate
On the balance of payments side, a capital inflow occurs and we experience a higher demand for
rands on the foreign exchange market.
This increase in the demand for rands results in an appreciation of the domestic currency (in
this case, the rand).
4. OPTION 1 In terms of the IS-LM model, the domestic equilibrium interest rate is determined by the interaction
between the goods market and the financial market. The goods market is represented by the IS
curve and the financial market by the LM curve. Also refer to figures 20.2(a) and (b) and the
explanation of this in the prescribed book.
An increase in the interest rate leads to a decrease in investment spending, the demand for goods
and the level of output and income.
The decrease in output and income is a multiple of the decrease in investment spending. This is due
to the multiplier effect.
A depreciation of the exchange rate results in an increase in exports and a decrease in imports due
to expenditure switching, thus the trade balance improves. The increase in exports and expenditure
switching increases the demand for goods and the level of output and income.
5. OPTION 5 A decline in the interest rate causes a depreciation of the nominal exchange rate. The depreciation of
the nominal exchange rate is the result of the decrease in the domestic interest rate relative to the
interest rate in the rest of the world. This causes domestic bonds to be less attractive and a capital
outflow occurs. This capital outflow reduces the demand for the domestic currency (it increases the
demand for foreign currency) and the exchange rate depreciates. The depreciation of the exchange
rate reduces the price of exports and exports increase which, in turn, increases the demand for
goods and the level of output and income.
By implementing, at the same time, an expansionary monetary policy the negative impact of a
6. OPTION 3
contractionary fiscal policy on the level of output is softened. An increase in the money supply
, decreases the interest rate and, as the interest rate is decreased, investment spending, the demand
for goods and the level of output rise. In terms of our IS-LM model model this is represented as
downward shift of the LM curve.
7. OPTION 3 A depreciation of the exchange rate results in an increase in exports and a decrease in imports due
to expenditure switching, thus the trade balance improves. The increase in exports and expenditure
switching increases the demand for goods and the level of output and income.
8. OPTION 3
.
9. OPTION 4 Since the interest rate is set by the central bank, the interest rate will be unchanged
(i = i¯) and therefore the exchange rate is also unchanged.
The increase in the level of output and income will increase the demand for money
and the quantity of money
Impact on the trade balance
The increase in the level of output and income results in an increase in imports and
a deterioration of the trade balance
10. OPTION 1
11. OPTION 4
With Explanations
For Assistance: Call +27 61 844 1387
1. OPTION 2 Reference: Study Guide PG 145
The correct option is 2. According to the interest-parity relation a higher domestic interest rate leads
2. OPTION 2 to an appreciation of the nominal exchange rate (i↑ → E↑). The opposite will also be true (i↓ → E↓).
3. OPTION 5 In the above example, the interest parity condition holds which means that the domestic interest rate
approximately equals the foreign interest rate minus the expected rate of appreciation of the
domestic currency. But what happens if, for some reason, the domestic interest rate increases to
10%? At a domestic interest rate of 10%, given that the nominal exchange rate is R1 = $0.20, the
interest parity condition no longer holds since the expected rate of return on domestic bonds is
greater than that of foreign bonds. For interest parity to be re-established, the current exchange rate
will have to appreciate
On the balance of payments side, a capital inflow occurs and we experience a higher demand for
rands on the foreign exchange market.
This increase in the demand for rands results in an appreciation of the domestic currency (in
this case, the rand).
4. OPTION 1 In terms of the IS-LM model, the domestic equilibrium interest rate is determined by the interaction
between the goods market and the financial market. The goods market is represented by the IS
curve and the financial market by the LM curve. Also refer to figures 20.2(a) and (b) and the
explanation of this in the prescribed book.
An increase in the interest rate leads to a decrease in investment spending, the demand for goods
and the level of output and income.
The decrease in output and income is a multiple of the decrease in investment spending. This is due
to the multiplier effect.
A depreciation of the exchange rate results in an increase in exports and a decrease in imports due
to expenditure switching, thus the trade balance improves. The increase in exports and expenditure
switching increases the demand for goods and the level of output and income.
5. OPTION 5 A decline in the interest rate causes a depreciation of the nominal exchange rate. The depreciation of
the nominal exchange rate is the result of the decrease in the domestic interest rate relative to the
interest rate in the rest of the world. This causes domestic bonds to be less attractive and a capital
outflow occurs. This capital outflow reduces the demand for the domestic currency (it increases the
demand for foreign currency) and the exchange rate depreciates. The depreciation of the exchange
rate reduces the price of exports and exports increase which, in turn, increases the demand for
goods and the level of output and income.
By implementing, at the same time, an expansionary monetary policy the negative impact of a
6. OPTION 3
contractionary fiscal policy on the level of output is softened. An increase in the money supply
, decreases the interest rate and, as the interest rate is decreased, investment spending, the demand
for goods and the level of output rise. In terms of our IS-LM model model this is represented as
downward shift of the LM curve.
7. OPTION 3 A depreciation of the exchange rate results in an increase in exports and a decrease in imports due
to expenditure switching, thus the trade balance improves. The increase in exports and expenditure
switching increases the demand for goods and the level of output and income.
8. OPTION 3
.
9. OPTION 4 Since the interest rate is set by the central bank, the interest rate will be unchanged
(i = i¯) and therefore the exchange rate is also unchanged.
The increase in the level of output and income will increase the demand for money
and the quantity of money
Impact on the trade balance
The increase in the level of output and income results in an increase in imports and
a deterioration of the trade balance
10. OPTION 1
11. OPTION 4
