INTERNATIONAL MONEY AND FINANCE
(15ECC003)
January 2016 3 Hours
Answer THREE questions.
All questions carry equal marks.
Calculators are not permitted.
1. Within the context of the flexible monetary model of exchange rate determination,
examine separately the effects of the following under both fixed and flexible
exchange rates:
(a) (i) an increase in domestic income
(ii) a rise in the foreign price level.
(b) Briefly explain the contribution and the limitations of the model.
2. “Despite its empirical inadequacies, purchasing power parity, PPP, has remained
an important concept in international finance”. Critically discuss.
3. (a) Critically evaluate the current Euro-Area as an optimum currency area.
(b) Explain how flexibility of domestic wages and prices in the individual member
countries of the Euro-zone could influence the ability of the union to sustain
itself over time.
4. Consider the Mundell-Fleming model in which there is perfect asset substitutability
and perfect capital mobility where the interest rate parity holds with i=i F , where i is
the domestic nominal interest rate and i F is the foreign nominal interest rate.
Suppose that the domestic monetary authorities decide to undertake a
contractionary monetary policy:
(a) What are the initial effects of this monetary policy on the goods market, the
money market, the foreign exchange market, and the balance of payments of
the domestic economy? Which curves shift?
(b) What is the adjustment mechanism under fixed exchange rate regime?
Illustrate and explain which curves will shift during the adjustment process
and then compare the new equilibrium with the initial equilibrium.
(c) What is the adjustment mechanism under a flexible exchange rate regime?
Illustrate and explain which curves will shift during the adjustment process,
and then compare the new equilibrium with the initial equilibrium.
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