Unit 5: International Economics

Answer: A — Demand increases due to higher returns is correct because higher interest rates make a country's currency more attractive to investors, increasing demand.

Answer: C — Negative is correct because the current account balance (CA) equals national savings (S) minus domestic investment (I). Given S = $1.2T and I = $1.5T, CA = S - I = $1.2T - $1.5T = -\$0.3T, which is negative, indicating a current account deficit. The net capital inflow is also \$0.3T, as the country needs to finance its domestic investment in excess of its savings.

Answer: E — decrease the demand for foreign currency is correct because a tariff reduces imports, decreasing the demand for foreign currency to purchase those imports. This would cause the nation's currency to appreciate.

Answer: A — Net capital outflow is correct because a trade deficit indicates a net capital outflow, meaning more funds are leaving the country than entering..

Answer: E — Raise interest rates is correct because to defend the peg, the central bank must attract foreign capital to replenish its reserves. Raising interest rates will increase the return on domestic assets, attracting foreign investors and increasing the demand for the domestic currency, thus defending the peg. Lowering interest rates or increasing the money supply would have the opposite effect, while implementing tariffs may not directly address the reserve depletion. Devaluing the domestic currency would abandon the fixed peg.