Question Details

This worst of all possible worlds most likely happened because the Fed effort to lower interest rates 



1. "At the same time that Secretary Blumenthal was testifying to Congress, the Treasury borrowed $1.6 billion in Germany in the form of securities denominated in marks. It offered to pay a interest rate of roughly 6% per year on mark-denominated three- and four-year securities. On comparable securities denominated in dollars, the Treasury is currently paying a bit over 9% - or three percentage points per year more." Germans are willing to invest at 6% when 9% is available because 131 
a) they are very nationalistic b) the risk premium is not large enough 
c) they expect the value of the US dollar to fall by more than 3% per year 
d) they expect the value of the German mark to rise by less than 3% per year 
2. "He can't understand why Americans would put their money in three-year paper at 9% when they can get double-A rated New Zealand bonds at 19%." This happens because of 
a) a huge risk premium b) ignorance on the part of U.S. investors 
c) a higher inflation in New Zealand than in the U.S. 
d) an expected rise in the value of the New Zealand dollar. 
3. "The Fed has made occasional attempts to lower interest rates and accept some lowering of the dollar as a tradeoff. Sometimes it works, and sometimes, like last summer, we end up with the worst of all possible worlds - higher interest rates and a lower dollar." This worst of all possible worlds most likely happened because the Fed effort to lower interest rates 
a) increased inflation which increased the nominal interest rate and depreciated the dollar 
b) caused capital inflows to fall, lowering the exchange rate which raised costs and thus increased the interest rate 
c) caused a balance of payments surplus which automatically increased the money supply, causing inflation which lowered the exchange rate and increased the nominal interest rate 
d) increased the money supply which under a flexible exchange rate depreciated the dollar which required a higher interest rate to attract capital inflows for international balance 
4. "This does not mean there is a massive flow of U.S. funds into Canada, because the differentials are mitigated by other factors. The discount on the forward Canadian dollar has kept step with the interest rate differential, and it is only on an unhedged basis that the full advantage of the differential can be gained." The discount on the forward Canadian dollar keeping in step with the interest rate differential means that the interest rate differential 
a) should produce a steady rise in the value of the Canadian dollar 
b) is producing capital flows that are causing expected changes in the exchange rate 
c) is a difference in real interest rates and so influences the future value of the exchange rate 
d) reflects inflation differentials and so the exchange rate is expected to change by an equal amount 
5. "Before the advent of modern international financial markets in the mid 1970s, domestic financial markets placed a serious constraint on the ability of governments to borrow their way to popularity or prosperity. Historically, domestic financial markets were largely closed systems where excessive borrowing by governments led quickly to ....." Complete this clipping. 
a) inflation b) lower taxes c) unemployment d) higher interest rates



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