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ECS2602 ASSIGNMENT 2 OF 2021
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ECS2602/001/3/2021ASSIGNMENT 03
LEARNING UNITS 7, 8 and 9
DUE DATE: 2021/08/19
UNIQUE NUMBER: 704020
This assignment contributes 40% towards your semester mark.
Please ensure that this assignment reaches the university before the due date.
Answer all questions on a mark-reading sheet.
1. In an open economy, the impact of an increase in the interest rate on the demand for
goods and the level of output in the goods market can be illustrated by the following chain
of events:
1. i↑ → E↓ → X↑ → NX↓
2. i↑ → E↑ → X↓ → Z↓ → Y↓
3. E↓ → X↑ → NX↑ → Z↑ → Y↑
4. i↑ → I↓ → Z↑ → Y↑ → NX↓
2. According to the interest-parity relation ...
1. a higher domestic interest rate leads to a depreciation of the nominal exchange rate.
2. a higher domestic interest rate leads to an appreciation of the nominal exchange
rate.
3. the domestic interest rate has no impact on the nominal exchange rate.
4. a depreciation of the nominal exchange rate leads to a lower domestic interest rate.
5. an appreciation of the nominal exchange rate leads to a higher domestic interest
rate.
Question 3 is based on the following information:
Assume that the …
nominal exchange rate (E) is R1 = $0.20
expected exchange rate (at the end of the period E e) is R1 = $0.20
domestic interest rate (i) is 6%%
interest rate in the USA (i*) is 6%
33
,3. Which of the following statements are correct regarding the interest parity condition
relation?
a. The interest parity condition holds since the domestic interest rate
approximately equals the foreign interest rate minus the expected rate of
appreciation of the domestic currency.
b. Assume that the domestic interest rate increases to 12%. If this happens, the interest
parity condition no longer holds since the expected rate of return on domestic bonds
is higher than that of foreign bonds.
c. If the domestic interest rate increases from 6% to 12%, the current exchange rate will
depreciate to re-establish the interest parity condition.
d. If the domestic interest rate increases from 6% to 12%, the current exchange rate will
appreciate to re-establish the interest parity condition.
e. On the balance of payments side, a capital inflow occurs since there is 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.
1. a, b, c, and e
2. Only a, b and d
3. Only a, d and e
4. Only c and e
5. Only a, b, d and e
Question 4 is based on the following diagram:
4. Which of the following statements are correct?
a. The above diagram illustrates the IS-LM model for an open economy.
b. The IS curve is downsloping because an increase in the interest rate leads directly,
through investment, and indirectly, through the exchange rate to a decrease in
demand and the level of output and income.
c. The LM curve is horizontal at the interest rate set by the central bank.
d. Equilibrium output and the equilibrium interest rate are given by the intersection of
the IS and the LM curves.
e. Given the interest parity relation, the equilibrium interest rate determines the
equilibrium exchange rate.
34
, ECS2602/001/3/2021
1. a, b, c, d and e
2. Only a, c and e
3. Only b, c, d and e
4. Only a, c and d
5. Only a, c, d and e
5. In the IS-LM model for an open economy, a decrease in the interest rate by the monetary
authorities causes a(n) …
a. appreciation of the exchange rate and a decrease in exports.
b. increase in both government spending and the demand for goods.
c. increase in investment, the demand for goods and the level of output and income.
d. depreciation of the exchange rate and an increase in exports.
e. depreciation of the exchange rate and a decrease in imports.
1. a, c and d
2. a, c and e
3. Only c, d and e
4. b, c and d
5. None of the options 1 to 4
Questions 6 and 7 are based on the following diagram of an IS-LM model for an open economy.
6. Which one of the following statements is correct?
1. The diagram above illustrates the impact of a contractionary monetary policy on the
exchange rate.
2. The diagram above illustrates the impact of a contractionary fiscal policy on the
exchange rate.
3. The diagram above illustrates the impact of an expansionary monetary policy on the
exchange rate.
4. The diagram above illustrates the impact of an expansionary fiscal policy on the
exchange rate.
35
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