1. An economy begins in long-run equilibrium, and then a change in government regulations allows banks to start paying interest on checking accounts. Recall that the money stock (demand for money) is the sum of currency and including checking accounts, so this regulatory change makes holding money more attractive.

a. How does this change affect the demand for money?

b. What happens to the prices if the Central Bank does not respond?

c. Draw a graph showing the effect on prices.

2. Explain whether each of the following events increases or decreases the money supply.

a. The Central Bank sells bonds in open-market operations.

b. The CB increases the reserve requirement.

c. The CB increases the interest rate it pays on reserves.

d. Citibank repays a loan it had previously taken from the CB.

e. After a rash of pickpocketing, people decide to hold less currency.

f. Fearful of bank runs, bankers decide to hold more excess reserves.

3a. What is the current account balance of a nation with a government budget deficit of 128 € billion, private saving of 80 € billion, and domestic capital formation of 77 € billion?

3b. “A country is better off running a current account surplus rather than a current account deficit.” Do you agree or disagree? Explain.

3c. “National saving can be used domestically or internationally.” Explain the basis for this statement, including the benefits to the nation of each use of its saving.

4. During the first decade of the 2000s, the nation of Zimbabwe experienced one of history’s most extreme examples of hyperinflation. In many ways, the story is common: Large government budget deficits led to the creation of large quantities of money and high rates of inflation. The hyperinflation ended in April 2009 when the Zimbabwe central bank stopped printing the Zimbabwe dollar and the nation started using foreign currencies such as the U.S. dollar and the South African rand as the medium of exchange. Estimates vary about how high inflation in Zimbabwe got, but the magnitude of the problem is well documented by the denomination of the notes being issued by the central bank. Before the hyperinflation started, the Zimbabwe dollar was worth a bit more than one U.S. dollar, so the denominations of the paper currency were similar to those one would find in the United States. A person might carry, for example, a 10-dollar note in his wallet. In January 2008, however, after years of high inflation, the Reserve Bank of Zimbabwe issued notes worth 10 million Zimbabwe dollars, which was then equivalent to about 4 U.S. dollars. But even that did not prove to be large enough. A year later, the central bank announced it would issue notes worth 10 trillion Zimbabwe dollars, then worth about 3 U.S. dollars. As prices rose and the central bank printed ever-larger denominations of money, the older, smaller-denomination currency lost value and became almost worthless.

1. Highlight the common pattens that hyperinflations have in Zimbabwe

2. What was the central bank´s solution to hyperinflation?

3. Why the value of the Zimbabwe dollar changed over time?

5. What has happened to the exchange-rate value of the dollar in each case?

a. The spot rate goes from $1.25/SFr to $1.30/SFr.

b. The spot rate goes from SFr 0.80/$ to SFr 0.77/$.

c. The spot rate goes from $0.010/yen to $0.009/yen.

d. The spot rate goes from 100 yen/$ to 111 yen/$.