Question

TRUE or FALSE??

If the Bank of England (BoE) responds to BREXIT panic by making £100b available to banks to make loans, we would expect to see

•a decrease in the £ interest rate

•an increase in the U.S. domestic interest rate, and

•depreciation of the £ vis-à-vis the $

Assume

Sticky prices (P is fixed); Fixed expectations about future exchange rates (Ee is fixed); the United States is HOME.

Answer 1

1. If the Bank of England (BoE) responds to BREXIT panic by making £100b available to banks to make loans, we would expect to see a decrease in the £ interest rate.

The statement is True, Because with 100 Billion Pound liquidity addition in Banking system, the reserves will rise and thus the short term interest rates will fall.

2.If the Bank of England (BoE) responds to BREXIT panic by making £100b available to banks to make loans, we would expect an increase in the US dometic interest rate.

The statement is False, because there is no relation of UK economy with US interest rates. The Bank of England forms policies for its own economy and it dosen't have effect on US interest rates. US Federal Reserve will hike rates if the US economy is growing at healthy growth rate and inflation is rising.

3. If the Bank of England (BoE) responds to BREXIT panic by making £100b available to banks to make loans, we would expect to depreciation of the £ vis-à-vis the $.

The statement is true. Because exchange rate movements depends on the short term interest rates. The country having higher short term interest rates will see appreciating currency against country with low rates. And when BOE decides to lower the short term interest rate in the marekt with 100 Billion Pounds liquidity injections, the capital will flow out of UK and move to other countries offereing higher rates or safer assets.