1.  Consider the following scenariofor a “three country world.” Annual CPI inflationin Switzerland and Australia is running at 5 and 10 percent, respectively. CPI deflation in Russia is proceeding at apace of 2 percent. Half of Russia’s international trade is with each tradingpartner and the ruble has appreciated by 2 percent against both the Swiss francand the Australian dollar.

a.    Has the ruble appreciated ordepreciated in real effective terms? By how much?

b.    In terms of Mankiw’s (smalleconomy) macroeconomic model how should this affect Russia’s national savingsand investment?

2.Many countries “sterilize” the impact of capital flows throughmonetary policy in order to keep the monetary base (high-powered money)constant.

a.    Why might countries seek tosterilize?

b.    How specifically would acountry employ open market operations to cope with capital outflows?

c.    How could the country achievethe same effect by influencing the money multiplier or by changing its fiscalpolicy stance?

3.  In recent years the USgovernment has repeatedly requested that China progressively move to a moreflexible exchange rate arrangement as a means to reduce the scope of globaleconomic imbalances and for China’s own economic benefit.

a.    What is the basic (economic)reasoning for such a policy change?

b.    What other factors in China andin the rest of the world could frustrate (or mute) the intended impact of thisalteration in China’s exchange rate regime from a more to less managed one?