What is the impact of the PBC’s policy of foreign currency purchase on the country’s money supply?

Assignment 4 (Short-Answer and Algebraic Questions): (The numbers in square brackets give the breakdown of the points for various parts of each question. To receive full credit, please explain your answers. Total of 60 points plus 10 points extra credit.)

  • This questions is based on the article, “Signs of a slowdown,” published by The Economist on June 6, 2015. The article discusses the trends in the value of the yen and its consequences during 2012 and 2015. The average annual rate of inflation during 2013 and 2014 was 1.55 percent in both the US and Japan. Assume that the yen is the home currency so that the exchange rate is expressed in terms of US dollars per yen and the appreciation/depreciation is calculated as the percentage change of that exchange rate.
  • This question is based on a speech, U.S. Economic Outlook and Monetary Policy, by the Fed Vice Chair Richard H. Clarida on May 21, 2020, at the New York Association for Business Economics. In that speech, Richard Clarida first lays out the economic outlook at the time and then discusses the Fed’s policy responses to the situation.
  • China has a trade surplus and the People’s Bank of China (PBC, China’s central bank) purchases all the excess foreign currency earning of the country’s exporters. This policy is equivalent to bond purchases by the PBC through open market operations.
  • The article and its chart[1] show that the yen-dollar exchange rate at the end of 2012 was e0 =1/87¥/$ and by the end of 2014 reached e1 = 1/120¥/$. By what percentage did the yen depreciate vis-à-vis the dollar in nominal terms in those two years? [4] By what percentage did the yen depreciate vis-à-vis the dollar in real terms in those two years? [3]
  • According to the article, what was the factor driving the depreciation of the yen against the dollar? [5]
  • The article points out that global trade of the main emerging markets except China and Hong Kong saw weaker exports in early 2015 compared to the situation during the same period in 2014. What were the causes of that sluggishness highlighted by the article? [7]
  • According to the article, in the situation prevailing in 2014 and early 2015, central banks were happy to see their currencies weaken. Why did this lead to exporting deflation to the rest of the world? [6]
  • Extra Points Question: The article states that “QE means that central banks are absorbing an awful lot of new government debt.” How does this help keep sovereign-bond yields low? What are the potential problems that this policy may cause for the world economy? [10]
  • In his speech, Clarida points out that while economic situation seemed dire at the time, financial conditions had improved considerably after mid-March. What was his explanation for this contrast between economic and financial circumstances? [6]
  • In his speech, Clarida mentioned a number of policy measures that the Fed had taken to reduce the economic and financial impact of the COVID-19 pandemic. Which measures that he mentioned were conventional and which ones were unconventional? [12]

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  • What is the impact of the PBC’s policy of foreign currency purchase on the country’s money supply? [7]
  • If all foreign conditions are exogenous and the aggregate real income, the price level, and the future conditions of the Chinese economy (including the expected exchange rate) can be taken as given, what is the consequence of the policy for the current interest rate and the spot exchange rate in China? [10]

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[1] The inverted scale used in the charts of the article is a fractional scale where the vertical axis label corresponds to the denominator of the fraction. So, a label of 120 corresponds to 1/120 dollars/yen.


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