Practice Question 2: Consider the central bank balance sheet for the country of Riqueza. Riqueza current has 2,000 million escudos in its money supply, 1,200 million escudos of which backed by domestic government bonds; the rest is backed by foreign exchange reserve Assume that Riqueza maintains a fixed exchange rate of one escudo per dollar, th foreign interest rate remains unchanged, and money demand takes the usua form n

ENGR.ECONOMIC ANALYSIS
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Chapter1: Making Economics Decisions
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Part D and E
A.Show Riqueza's central bank balance sheet, assuming there are no private banks. What is
the backing ratio?
B.Suppose that Riqueza's central bank buys 400 million escudos in government bonds.
Show how this affects the central bank balance sheet. Does this change affect Riqueza's
money supply? Explain why or why not. What is the backing ratio now?
C.Now, starting from this new position, suppose that there is an economic downturn in
Riqueza, so that real income contracts by 10%. How will this affect money demand in
Riqueza? How will forex traders respond to this change? Explain the responses in the
money market and the forex market.
D.Using a new balance sheet, show how the change described in part (c) affects Riqueza's
central bank. What happens to domestic credit? What happens to Riqueza's foreign
exchange reserves? Explain the responses in the money market and the forex market.
E.How will the change above affect the central bank's ability to defend the fixed exchange
rate? What is the backing ratio now? Describe how this situation differs from one in which
the central bank buys government bonds, as in part (b).
Transcribed Image Text:A.Show Riqueza's central bank balance sheet, assuming there are no private banks. What is the backing ratio? B.Suppose that Riqueza's central bank buys 400 million escudos in government bonds. Show how this affects the central bank balance sheet. Does this change affect Riqueza's money supply? Explain why or why not. What is the backing ratio now? C.Now, starting from this new position, suppose that there is an economic downturn in Riqueza, so that real income contracts by 10%. How will this affect money demand in Riqueza? How will forex traders respond to this change? Explain the responses in the money market and the forex market. D.Using a new balance sheet, show how the change described in part (c) affects Riqueza's central bank. What happens to domestic credit? What happens to Riqueza's foreign exchange reserves? Explain the responses in the money market and the forex market. E.How will the change above affect the central bank's ability to defend the fixed exchange rate? What is the backing ratio now? Describe how this situation differs from one in which the central bank buys government bonds, as in part (b).
Practice Question 2:
Consider the central bank balance sheet for the country of Riqueza. Riqueza currently
has 2,000 million escudos in its money supply, 1,200 million escudos of which is
backed by domestic government bonds; the rest is backed by foreign exchange reserves.
Assume that Riqueza maintains a fixed exchange rate of one escudo per dollar, the
foreign interest rate remains unchanged, and money demand takes the usual
form, M/P = L(i)Y. Assume prices are sticky.
Transcribed Image Text:Practice Question 2: Consider the central bank balance sheet for the country of Riqueza. Riqueza currently has 2,000 million escudos in its money supply, 1,200 million escudos of which is backed by domestic government bonds; the rest is backed by foreign exchange reserves. Assume that Riqueza maintains a fixed exchange rate of one escudo per dollar, the foreign interest rate remains unchanged, and money demand takes the usual form, M/P = L(i)Y. Assume prices are sticky.
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