Evaluating a Central Bank's Policy Proposal
The central bank of a major foreign economy maintains a stable policy interest rate of 3.5%. Financial markets, in a long-run equilibrium, expect the currency of a smaller home country to depreciate by 2.0% annually against this foreign currency. The governor of the home country's central bank proposes setting the domestic policy rate at 4.0% to stimulate the local economy. Evaluate this proposal. Is this rate consistent with a stable long-run equilibrium? Explain the likely consequences for international capital flows and the home country's exchange rate if this policy were implemented.
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Introduction to Macroeconomics Course
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Determining a Central Bank's Long-Run Policy Rate
Suppose the central bank of a large foreign economy sets its policy interest rate at 2.5%. In a stable, long-run equilibrium, financial markets anticipate that the home country's currency will depreciate by 3% annually against the foreign currency. To maintain this equilibrium, what policy interest rate should the home country's central bank set?
Calculating the Equilibrium Policy Rate
In a stable, long-run equilibrium, if a home country's central bank sets its policy interest rate at 7% while a major foreign economy's rate is 4%, financial markets must expect the home currency to appreciate by 3% annually for the equilibrium to be maintained.
In a stable, long-run financial equilibrium, the central bank of Country A sets its policy interest rate at 5.5%, while the central bank of Country B (a major trading partner) maintains its rate at 2.0%. For this equilibrium to hold, financial markets must expect the currency of Country A to depreciate against the currency of Country B by ____% annually.
An economic analyst is examining the long-run financial stability of three small open economies (A, B, and C) relative to a large foreign economy. The foreign economy has a stable policy interest rate of 3.0%. The analyst has gathered the following data for the three small economies:
- Country A: Policy rate is 5.0%; expected annual currency depreciation is 2.5%.
- Country B: Policy rate is 6.5%; expected annual currency depreciation is 3.5%.
- Country C: Policy rate is 2.5%; expected annual currency depreciation is -1.0% (i.e., an appreciation).
Based on this information, which country has set a policy interest rate that is consistent with a stable, long-run equilibrium in international financial markets?
An economist is analyzing four different small, open economies, each assumed to be in a stable, long-run financial equilibrium. For each economy, match the given financial conditions (foreign policy rate and expected annual currency depreciation) with the correct home policy rate required to maintain that equilibrium.
Evaluating a Central Bank's Policy Proposal
Central Bank Policy Dilemma
Assessing Financial Market Disequilibrium