Lecture Questions for Lecture 11

Why does a rise in interest rates cause capital inflows and an BOP surplus only for the short run? Once investors have adjusted their portfolios in response to the interest rate change, the capital flows will stop.
As a general rule of thumb, do developing nations choose a fixed exchange rate? If so, how long does it usually take to switch to a flexible one? Developing nations do tend to have a fixed exchange rate in order to give foreign investors confidence in their currency. Even if the exchange rate is technically flexible, governments intervene to maintain the rate at some desired level.
Is it normal for a country to incorporate a fixed exchange rate with some countries but be flexible with others? For example, if the Bahamas fixed to the U.S. but wouldn't they therefore be flexible to Japan? Countries will fix their exchange rates in a currency they expect to be fairly stable. No one fixes in terms of the Mexican peso. But, the yen price of the Bahamian currency would fluctuate with changes in the yen/$ rate.
Why does income go up if the value of the dollar does down? A fall in the value of the dollar makes U.S. goods relatively cheaper for foreign buyers so U.S. exports rise and imports fall. This increase in net exports raises aggregate demand. So, aggregate income rises by a multiplied amount.

David A. Latzko
318 COB
Department of Business and Economics
Wilkes University
Wilkes-Barre, PA 18766
phone: (717) 408-4718
fax: (717) 408-4917
dlatzko@wilkes.edu
wilkes1.wilkes.edu/~dlatzko