Problem Set # 8

Miguel D. Ramirez

International Finance

Econ. 316.

 1. Explain why a balance of payments deficit generates a decrease in the money supply of a country under fixed exchange rates. Using T accounts describe how the Central Bank=s balance sheet is affected.

 2. Using the banking information given below for a small Latin American economy operating under fixed exchange rates (and no capital mobility) answer the following questions all figures are in pesos):

Currency= 50 billion; Demand Deposits = 160 billion; bank reserves = 20 billion.

a. What is the monetary base, the money supply, and the money multiplier?

b. Suppose that during the month of May the country=s Central Bank losses international reserves by an amount equal to 10 billion pesos. Assuming Central Bank credit remains unchanged, what will be impact of the loss of reserves on: the monetary base, the money supply?

c. The government wants to keep the money supply unchanged in spite of the loss in reserves. What offsetting operations could it engage in? (For all these questions provide numerical answers and explain how they are obtained.)

3. Analyze the likely effects of an increase in the money supply (via an open market purchase of bonds) on an economy operating under fixed exchange rates and no capital mobility. Your answer should distinguish between the short-run and full-equilibrium effects on output, interest rates, and the trade balance.