Macroeconomics 12th Edition Gordon

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Chapter 7
International Trade, Exchange Rates,
and Macroeconomic Policy

◼ Chapter Outline

7-1 Introduction
a. What We Learn in This Chapter
b. The “Trilemma”

7-2 The Current Account and the Balance of Payments

a. The Current Account and the Capital Account
b. The Balance of Payments Outcome
c. Foreign Borrowing and International Indebtedness
d. Why Is U.S. Income from Abroad Still Positive?
e. The International Investment Position and the U.S. Standard of Living
f. The Current Account and National Saving

7-3 Exchange Rates

a. How Exchange Rates Are Quoted
b. Changes in Exchange Rates

7-4 The Market for Foreign Exchange

a. Why People Hold Dollars and Euros
b. How Governments Can Influence the Foreign Exchange Rate

7-5 Real Exchange Rates and Purchasing Power Parity

a. Nominal and Real Exchange Rates
b. The Theory of Purchasing Power Parity
c. PPP and Inflation Differentials
d. Why PPP Breaks Down

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 Chapter Overview 69

7-6 Exchange Rate Systems

a. Flexible Versus Fixed Exchange Rates
b. Workings of the Fixed Exchange Rate System
c. Characteristics of the Flexible Exchange Rate System
d. The Exchange Rate of the Dollar Since 1980
IP Box: Big Mac Meets PPP

7-7 Case Study: Asia Intervenes with Buckets to Buy Dollars and Finance the U.S. Current Account
Deficit—How Long Can This Continue?
a. How Large Are the Reserves and Which Countries Hold Them?
b. Why Do the Asians Subject Themselves to Disastrous Capital Losses?

7-8 Determinants of Net Exports

a. Net Exports and the Foreign Exchange Rate

7-9 The Real Exchange Rate and the Interest Rate

a. The Demand for Dollars and the “Fundamentals”
b. Interest Rates and Capital Mobility
c. The Two Adjustment Mechanisms: Fixed and Flexible Rates
d. Is Perfect Capital Mobility Relevant for the United States?

7-10 Effects of Monetary and Fiscal Policy with Fixed and Flexible Exchange Rates
a. The Analysis with Fixed Exchange Rates
b. The Analysis with Flexible Exchange Rates
c. How a Large Open Economy Differs from a Small Open Economy
Global Economic Crisis Focus: Is the United States Prevented from Implementing a Fiscal Policy
Stimulus by Its Flexible Exchange Rate?

7-11 Conclusion: Economic Policy in the Open Economy

a. The Trilemma, the United States, and the Euro

Summary

◼ Chapter Overview

This chapter connects the U.S. economy with the rest of the world. It explains the concepts of
export, import, and the basics of the U.S. balance of payments, the current account, the capital
account, and international indebtedness. It also exposes student to the role of the foreign exchange
rates and the causes of their changes. It extends the analysis of macroeconomic policy in the
context of an open economy that experiences flows of goods, services, and capital to and from
other countries under fixed and flexible exchange rate regime for a small open economy as well as
a large open economy.

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70 Chapter 7 International Trade, Exchange Rates, and Macroeconomic Policy

In Section 7-1 he also introduces the concept of “trilemma” as a unifying concept for the chapter.
This is the inability of a country to maintain independent control of its monetary policy under
conditions of fixed exchange rates and free capital flows with other countries. Gordon explains
how the United States is affected by the trilemma over the last few decades. While the United
States adopts flexible exchange rates, some foreign nations, in particular China and Japan, have
kept their own exchange rates fixed to the U.S. dollar, preventing the dollar from appreciating.
Section 7-2 teaches students the consequences of government budget surpluses or deficits and trade
balances on national saving. Define national saving as the sum of private saving (S) and
government saving (the budget surplus T – G). Remind students that national saving is equal to
domestic and foreign investment through the “magic” equation: S + (T = G)  I + NX. In this
section, Gordon discusses the key concepts of international macroeconomics: these are current,
capital account, balance of payments, and international indebtedness. Students already know that
counterparts of the flow of goods and services counted as exports and imports are offsetting capital
flows. Problems arise when a country’s inflows of goods, services, and capital do not match
outflows. This section describes how these flows are measured in the measurement of balance of
payments. Distinguish between the current account and the capital account and explain that the
balance of payments is the sum of the balances in these two accounts. In the lecture, be sure
students understand that a credit item in these accounts is anything that leads to a flow of “money”
into the United States and that a debit is an outflow of “money.” This concept is straightforward for
the current account, where foreign purchases of domestic goods (exports) represent an inflow of
foreign currency in exchange for the domestic goods, while domestic purchases of foreign goods
(imports) represents an outflow of domestic currency in exchange for foreign goods. The current
account also includes credits and debits that arise from flows of investment income and transfer
payments into and out of a country. Thus, a current account surplus is simply the excess of credits
over debits or a positive net inflow of “currency.” However, students often get confused over the
accounting procedure of the capital account, which specifies that credits are generated when the
United States becomes indebted to foreigners. Explain that the capital account represents a transfer
of bonds or other assets (rather than goods) between countries. When the United States borrows
from foreigners by selling them securities, it results in an inflow of money into the United States
and thus a credit in the capital account. The difference is that a capital account credit results from
selling domestic securities rather than goods to foreigners. Stress the particular role of the U.S.
dollar in explaining how these accounts are “balanced.” Point out that it is simply an accounting
identity that the amount of dollars actually purchased and the amount of dollars actually sold are
equal. Also note that these accounts include the reserve and assets transactions of domestic and
foreign governments as well as private transactions. Stress that a balance-of-payments deficit or
surplus represents the net private inflow or outflow of money reflected in the current and capital
accounts. Official government transactions represent the activities of the central bank in financing a
balance-of-payments deficit. These can either take the form of (a) creating an outflow of
international reserves at the IMF or (b) increasing the dollar reserves held by foreign central banks.
To the extent that foreign central banks are willing to accumulate U.S. dollars in their official
reserve holdings, the United States need not run down its own holdings of gold or foreign exchange
to finance a deficit. Finally, stress that what matters to economic growth is not the balance-of-
payments surplus, but the current account deficit matched by a large capital account surplus. A
country’s current account balance measures the change in its net international investment position.
Persistent current account deficits have caused the U.S.’s position to shift from surplus to

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 Chapter Overview 71

indebtedness. The debtor position resulting from the huge foreign capital inflow implies that the
interest and dividend payments to foreigners will transfer real resources from the domestic
economy and reduce the future standard of living. Also explain the concept of “net revaluations” in
the context of international investment, because this breaks the tight link between the current
account and the change in net international investment and explains why the large current account
deficit of the United States in 2000–10 did not erode the international investment position. In
concluding Section 7-2, Gordon explains how the change from positive U.S. international
investment position in 1975–85 to the large negative position in 2000–10 did not cause net income
from abroad to be negative. But he warned that this continuous current account deficit implies a
future adverse effect on the U.S. standard of living.
Section 7-3 explains how exchange rates are quoted and reported in the financial press. Be sure that
students know that the exchange rate of, say, yen for dollars is the reciprocal of the exchange rate
of dollars for yen and understand the meaning of currency appreciation and depreciation. Tell the
students that it is conventional to report exchange rates as foreign currency for one U.S. dollar,
with two exceptions: it is always dollars per British pound and always dollars per euro.
Section 7-4 uses a simple supply-and-demand model to explain equilibrium exchange rate
determination. The exchange rate is expressed in units of foreign currency per one unit of domestic
currency. Your lecture should identify the sources of supply and demand in the foreign exchange
market and relate these to credits and debits in the balance of payments. The demand for domestic
currency springs from domestic exports and capital inflows, while the supply of domestic currency
arises from domestic imports and capital outflows. Point out that the demand curve for domestic
currency will be negatively sloped as long as foreign demand for domestic exports is not perfectly
price inelastic, while the supply curve of domestic currency will slope upward if the domestic
demand for imports is price elastic. Also stress that changes in the flows of goods, services, and
capital between countries that are not themselves caused by changes in the exchange rate will shift
the demand for and supply of domestic currency and cause the exchange rate to appreciate or
depreciate. The supply–demand analysis of Figure 7-3 can also be used when discussing fixed
exchange rates. You may also want to relate the supply-demand analysis to the balance-of-
payments account. For a balance-of-payments deficit, the U.S. government (or, for that matter, a
foreign government such as China or Japan) can only maintain the higher-than-equilibrium
exchange rate by purchasing the excess supply of dollars. The United States purchases dollars by
depleting its reserves of foreign currencies and gold. China and Japan use yuan and yen to buy U.S.
dollars. Students might find this easier to understand if you tell them that it is perfectly analogous
to the way governments can maintain agricultural price supports.
Section 7-5 presents the concepts of the nominal and the real exchange rate and the theory of
purchasing-power-parity (PPP). It begins by establishing the relation between real (e) and nominal
(e) exchange rates: e = e  P/Pf, where P = the domestic price level and P f = the foreign price
level. This relation is explained with a numerical example involving the Mexican peso/dollar
exchange rate. The main implications of PPP are that the long-run real exchange rate should be
constant and the growth rate of the nominal exchange rate should equal the inflation differential
between foreign and domestic inflation. Countries with relatively rapid rates of inflation tend to
have depreciating currencies. Nevertheless, there have been numerous examples when this PPP
breaks down. Among the reasons that PPP has failed are rapid technological change and new
product innovation, new discoveries of natural resources, large capital movements, and government

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72 Chapter 7 International Trade, Exchange Rates, and Macroeconomic Policy

intervention in foreign trade and the exchange markets. Another criticism of PPP is that it implies
the constancy of real exchange rates, but real exchange rates have actually been very volatile. As
students will see later in the chapter, this can contribute to aggregate demand instability.
Section 7-6 then explains exchange rate systems. Distinguish between flexible and fixed exchange
rate regimes. Use the supply–demand model of exchange rate determination to explain and
compare the workings of each system. Contrast currency devaluation and revaluation under fixed
exchange rates with depreciation and appreciation in the flexible rate system. Also mention the role
of central bank intervention in the flexible rate system and distinguish between a “clean” and
“dirty” flexible exchange rate system.
Section 7-7 presents a case study of the Asian intervention to buy dollars and finance the U.S.
current account deficit. The United States escapes the trilemma by maintaining flexible exchange
rates with its trading partners, but it cannot force its trading partners to reciprocate. In the face of
persistent U.S. trade deficits that would lead to a depreciation of the dollar in a pure flexible
exchange rate system, The Bank of China has purchased vast quantities of dollars in an attempt to
maintain the yuan to dollar exchange rate fixed. By not allowing the yuan to appreciate, the Bank
of China hoped to keep Chinese exports high. However after 2005, they have allowed the dollar to
depreciate very slowly and by a very small amount, and as a result, the yuan to dollar exchange rate
has declined from 8.27 to 6.8 Yuan per dollar, which is much higher than the equilibrium exchange
rate. Hong Kong also tries to keep a fixed exchange rate against the American dollar by purchasing
dollars. Japan and Taiwan regularly buy dollars but do not keep their currencies fixed against the
dollar. All of these dollar purchases mean that Asian nations have been willing to finance U.S.
current account deficits. It is unclear whether this state of affairs is sustainable, or whether the U.S.
dollar will collapse at some point in the future.
Sections 7-8 through 7-10 develop the linkage between the exchange rate and income
determination and policy analysis. Section 7-8 discusses the determinants of net exports. In Figure
7-6, the net export line is plotted together with the real exchange rate. These figures support the
economic reasoning that net exports depend negatively on income (an idea introduced in Chapter
3) and the exchange rate. Stress the reason for the latter relationship. Given U.S. and foreign prices,
an appreciating exchange rate in essence raises the price of U.S. goods relative to the price of
foreign goods, and vice versa.
Section 7-9 includes a brief discussion on what “fundamental” factors might affect the foreign
demand for dollars and U.S. supply of dollars. Stress that the interest rate of U.S. securities relative
to foreign securities has an immediate and direct impact on the foreign demand for U.S. dollars.
Therefore, the interest rate is a very important determinant of the foreign exchange rate. Figure 7-7
provides empirical support for this relationship for the time period of 1980–2010. The text
introduces capital mobility as the means by which interest rates affect exchange rates. Finally, it is
explained that the positive relationship between the real interest rate and the real exchange rate
appears to have broken down after 1995, as a result of the huge foreign capital inflows resulting
from the U.S. stock market boom. The huge foreign capital inflows pushed up the value of the
dollar without an increase in the real interest rate.

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 Changes in the Twelfth Edition 73

Section 7-10 develops the Mundell–Fleming version of the IS-LM model. It analyzes the case of a
small open economy under both fixed and flexible exchange-rate regimes. In both cases, monetary
and fiscal expansions are treated. In a small open economy, because of perfect capital mobility, the
domestic interest rate must equal the foreign interest rate in order to prevent unlimited capital
inflows or outflows. Gordon shows that the central bank is impotent in the small open economy.
Fiscal policy, on the other hand, is powerful, and it forces an accommodating monetary policy. The
reverse is the case under flexible exchange rates. Be sure students are clear that there are two types
of open economies that are analyzed in the text. The open economy with fixed exchange rates was
introduced in Chapter 3, although without that terminology. There, net exports consisted of an
exogenous component and an income-induced component. The induced component has the effect
of reducing the multiplier by increasing the marginal leakage rate. The “flexible exchange rate
economy” modifies the model of Chapter 3. Here, the text explicitly includes exchange rates as a
determinant of net exports. It endogenizes the exchange rate by relating it to the interest rate
through capital flows. Next, Gordon generalizes the discussion to the large open economy where
domestic interest rate may be different from foreign interest rate. But the qualitative results
concerning policy effectiveness are almost the same as for the small open economy. These are
summarized at the end of this subsection.
Section 7-11 concludes the chapter by referring once again to the problem of trilemma. The case of
the United States, whose reliance on flexible exchange rates allows it to maintain independent
control of monetary policy despite free capital flows, is contrasted with that of the euro, where
eleven European countries have agreed to give up independent control of their monetary policy in
order to maintain a fixed exchange rate. Gordon points out that the United States and the major
Asian countries, especially China and Japan, have entered into a mutually reinforcing relationship
of codependence.

◼ Changes in the Twelfth Edition

This chapter has gone through substantial changes from the earlier edition. Actually, this chapter is
the outcome of reorganization of two chapters (5 and 6) from the 11th edition. It is created by
taking few sections of Chapter 5 and the major part of Chapter 6.
Introduction of the chapter is completely rewritten. In Table 7-2, U.S. Balance of Payment position
has been updated with data up to the year 2010. Similarly all the figures in this chapter has been
updated with newer information up to the year 2010. In the IP Box on the Big Mac Meets PPP has
been modified substantially and the accompanying table for Cash and Carry: The Hamburger
Standard has been also modified using different set of countries and different date for the journal
“Economist.” The case study of Asian intervention in foreign exchange markets that finance the
U.S. current account deficits has been slightly modified and updated with new information about
Japanese and Chinese strategy regarding the exchange rate for Yen and Yuan. Sections 7-10 and
7-11 remain almost same as Sections 6-9 and 6-10 in the 11th edition. In Section 7-10 he has added
Global Economic Crisis Focus: Is the United States Prevented from Implementing a Fiscal Policy
Stimulus by Its Flexible Exchange Rate?
Questions have been changed and also reorganized from two chapters of the previous edition.

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74 Chapter 7 International Trade, Exchange Rates, and Macroeconomic Policy

Answers to New Chapter 7

◼ Answers to Questions in Textbook

1. Any international transaction that creates a payment of money to a U.S. resident generates a credit. Any
international transaction that creates a payment of money to a foreigner by a U.S. resident is a debit.
2. The current account includes exports and imports, receipts and payments of investment income, and
transfer payments. The capital account includes purchases of foreign assets by U.S. residents and
purchases of U.S. assets by foreigners.
3. a. Credit; current account; decreases U.S. balance of payments deficit.
b. Debit; capital account; increases U.S. balance of payments deficit.
c. Credit; capital account; decreases U.S. balance of payments deficit.
d. Debit; current account; increases U.S. balance of payments deficit.
4. a. Net foreign investment position will improve by 100 billion dollars. Thus, it will be lower than $600
billion.
b. The dollar appreciates; thus, U.S. foreign assets are worth less, so the net foreign investment
position will worsen, and it will be more than $600.
5. Equation 7-2 on page 195 explains how this possible. There is no change in the net international
investment position if a current account deficit is offset by increased asset valuations. The dollar
depreciation during this time period made U.S. foreign assets worth more.
6. Given that the United States’ net borrowing from the rest of the world has become an ever larger
percentage of GDP since 1990, our net investment income would be negative if the rate-of-return we
paid on what we had borrowed was the same as or less than the rate-of-return we earned on those funds
we had lent to the rest of the world. But the fact that net investment income is still positive means that
we are earning a rate-of-return on our investments abroad that is sufficiently higher than we are paying
to foreigners for the funds they have lent to us to overcome the fact that we are net borrowers from the
rest of the world.
7. National saving is the sum of the saving done by households and businesses, denoted S and called
private saving, and government saving, which is positive when there is a government surplus and
negative when there is a government deficit. Therefore a rise in the government deficit reduces national
saving.
Equation 7.5 on page 198 shows that foreign investment is the difference between domestic investment
and national saving. Since a rise in the budget deficit reduces national saving, the rise requires either a
decrease in domestic investment to match the reduction in national saving or a rise in foreign
investment if the reduction in domestic investment is less than the reduction in national saving.
8. The dollar has appreciated against a currency if the number of units of that currency a dollar can
purchase has risen over the last year. If the number of units of a currency that can be bought with a
dollar has fallen over the course of a year, then the dollar has depreciated against that currency.
9. The demand for a country’s currency by foreigners (foreign exchange) is negatively sloped if the
demand for that country’s exports is negatively sloped.
10. The supply of a country’s currency to foreigners (foreign exchange) is positively sloped if the demand
by that country for imports is price elastic. For example, a depreciation of the foreign exchange rate of
the dollar relative to the euro (euro/$) will raise the dollar price of German goods. If the U.S. demand

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 Answers to Questions in Textbook 75

for German goods is price elastic, then each percentage-point rise in the dollar price will be
accompanied by a greater than one percent reduction in quantity demanded of German goods. The total
expenditure in dollars will fall. Thus, a decrease in the foreign exchange rate (euro/$) is associated with
a decrease in the quantity supplied of dollars, so the supply curve of dollars will be upward sloping.
The foreign-exchange supply curve is negatively sloped if the demand for foreign goods is price
inelastic. For example, a depreciation of the foreign exchange rate of the dollar relative to the mark
(euro/$) will raise the dollar price of German goods. If the U.S. demand for German goods is price
inelastic, then each percentage-point rise in the dollar price will be accompanied by a smaller than one
percent reduction in quantity demanded of German goods. The total expenditure in dollars will rise.
Thus, a decrease in the foreign exchange rate (euro/$) is associated with an increase in the quantity
supplied of dollars, so the supply curve of dollars will be downward sloping.
11. a. The demand for the Russian currency, the ruble, rises as other nations need to buy the ruble in order
to pay for the oil that they import from Russia. This causes the ruble to be overvalued relative to its
implied purchasing-power-parity value.
b. The demand for the dollar falls as Euro zone nations import a smaller amount of U.S. produced
entertainment. This causes the value of the dollar to be undervalued relative to its implied
purchasing-power-parity value.
c. The demand for the Indian currency, the rupee, rises as funds flow into the Indian stock market
from abroad. This causes the rupee to be overvalued relative to its implied purchasing-power-parity
value.
12. A “clean” flexible exchange rate system, in which the dollar and other currencies fluctuate freely,
becomes “dirty” when central banks intervene in foreign exchange markets to maintain a preferred
value for a currency. For example, central banks in Europe and Japan might intervene to support the
dollar, fearing that a fall in exchange rates would increase the competitiveness of U.S. exports in world
markets and reduce American demand for imports. The Fed might also intervene to support the dollar
to avoid the boost that higher import prices might give to U.S. inflation.
13. The Bank of China bought dollars during the period from 1995–2005 as needed in order to maintain an
essentially fixed exchange rate between the dollar and the yuan. It did so in an effort to maintain a low
exchange rate for the yuan so that the prices of Chinese made goods would remain low in the United
States. Those low prices enabled Chinese economic growth to stay higher than it would have been if
the yuan had risen in value relative to the dollar.
14. A country’s foreign exchange rate and its net exports are inversely related. When a country’s foreign
exchange rate appreciates, the price of its exports rises in terms of foreign currencies. Similarly, the
price of its imports falls in terms of its currency. Consequently, its firms export fewer goods and
services, and its citizens import more goods and services, causing its net exports to fall. The reverse
holds when the country’s foreign exchange rate depreciates.
15. The demand for the country’s currency rises as a result of the increase in its interest rate, since the
return on assets of that country increases, or foreigners want to hold that currency. Other things being
equal, that increase in demand results in a rise in the country’s foreign exchange rate.

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76 Chapter 7 International Trade, Exchange Rates, and Macroeconomic Policy

16. In order to pay for the exports, other countries need to purchase the country’s foreign exchange, which
increases the demand for the foreign exchange. The increase in demand is shown graphically by a shift
to the right of the demand curve for the foreign exchange and results in a rise of the foreign exchange
rate. If the country’s policymakers wish to prevent the rise in the foreign exchange rate, they have to
sell enough of the currency to provide an increase in the supply of the currency sufficient to match the
increase in demand.
17. If the Japanese economy had been suffering from rising inflation over the past decade, then its
government would have been taking steps to slow its growth. If that had been the case, the Japanese
government would, in all likelihood, have welcomed an appreciation of the yen versus the dollar. That
appreciation would have first, reduced the net exports of Japan, further slowing the growth of the
Japanese economy, and second, put pressure on those Japanese companies facing competition from
American firms to hold down price increases. Both effects of the yen’s appreciation would have been
desirable from the point of view of the Japanese government, given an objective of trying to reduce
inflation. Hence, it would have been far less willing to finance the United States’ current account
deficit.
Alternatively, the Japanese government would have had to sell yen in order to prevent a rise in the
value of the yen versus the dollar. But the sale of yen would have increased the money supply and
resulted in an increase in real GDP. That increase in real GDP would have added to the inflationary
pressures in the economy. As a result, it is unlikely that the Japanese government would have been
unwilling to sell yen to maintain the value of the yen against the dollar.
18. The trilemma is that it is not possible for a country to maintain independent control of its monetary
policy and fixed exchange rates and free flows of capital from other nations. The United States has
dealt with the trilemma by attempting to maintain independent monetary policy and free flows of
capital, but giving up fixed exchange rates in favor of flexible exchange rates. Ireland has dealt with the
trilemma by maintaining fixed exchange rates as a Euro zone nation and free flows of capital, but it has
given its authority over monetary policy to the European Central Bank.
19. Since the United States is a large open economy with flexible exchange rates, we know that
policymakers must use monetary policy to reduce real GDP relative to natural real GDP in an effort to
restrain a rise in inflation. In particular, monetary authorities need to reduce the real money supply,
resulting in a rise in the interest rate relative to those in the rest of the world. The higher relative
interest rate by itself will slow growth. In addition, the higher relative interest rate results in capital
inflows. The capital inflows lead to an appreciation of the dollar which causes a fall in net exports. The
fall in net exports causes an additional reduction in real GDP relative to natural real GDP.
On the other hand, Ireland has ceded control over domestic monetary policy to the European Central
Bank. Therefore, it can only use fiscal policy to reduce real GDP relative to natural real GDP. We also
know that fiscal policy is very powerful in a small open economy with fixed exchange rates.
20. A fiscal expansion increases interest rates, but, with perfect capital mobility, higher interest rates attract
capital inflows. This increased demand for the country’s currency would put upward pressure on its
foreign exchange rate. To maintain the fixed exchange rate, therefore, the central bank must increase
the money supply to bring down the interest rate and, thereby, the capital inflow. A fiscal contraction
would produce lower interest rates, a capital outflow, an increased supply of the country’s currency on
the foreign exchange market, a tendency for the country’s foreign exchange rate to fall, and an
offsetting decrease in the money supply by the country’s central bank to maintain the fixed exchange
rate. Therefore, monetary policy must accommodate fiscal policy.
21. If actual real GDP is less than natural real GDP, then that requires that policymakers take steps to
reduce actual real GDP relative to natural real GDP in order to reduce unemployment. In the case of
fiscal policy, that would involve cutting taxes or raising spending, steps that historically this economy’s

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 Answers to Problems in Textbook 77

fiscal policymakers have been unwilling to take. That means in this economy, only monetary
policymakers have the will to take actions that can permanently increase actual real GDP relative to
natural real GDP. Monetary policy is incapable of permanently raising real output under a fixed
exchange rate system in a large open economy; it can only do so under a flexible exchange rate system
in the same type of economy. Therefore, this economy would be best advised to adopt a flexible
exchange rate system so that it retains the ability to fight unemployment.
22. For a large country like United States, capital mobility is imperfect. A large country has substantial
control over the domestic interest rate. Expansionary monetary policy under a flexible exchange rate
will shift the LM curve toward right, leading to a decline in the domestic interest rate immediately.
This, in turn depreciates the domestic currency (exchange rate depreciates), leading to an increase in
net exports, thus shifting the IS curve to the right. Equilibrium income increases. This increase in
income will be larger than in the case of small economy where capital mobility is perfect. This higher
income in the new equilibrium position is accompanied by higher interest rate. This higher interest rate
may cause decline in private investment in the domestic economy in future. On the other hand,
expansionary fiscal policy is impotent in the flexible exchange rate regime just like in the case of small
country. (See pages 221–22 in the textbook.)

◼ Answers to Problems in Textbook

1. The current account balance is the sum of net exports (40), transfer payments (20), and net investment
income (–15), or 45. The capital account balance equals the balance minus the current account, or
10 – 45 = –35.
2.
Change in Change in U.S.
Current account Change in net foreign owned owned assets
Year balance int. inv. position assets in U.S. overseas
1 –500 –360 110 250
2 –550 –360 160 350
3 –380 –155 –375 –150
4 –640 –670 0 –30

a. +140, +190, +225, –30

b. 250
c. –550
d. –155
e. 0.
3. a. The points on the demand curve are: (2,800, 0); (2,600, 1); (2,400, 2); (2,200, 3); (2,000, 4); (1,800,
5); (1,600, 6); (1,400, 7); (1,200, 8); (1,000, 9); (800, 10); (600, 11); and (400, 12). The points on
the supply curve are: (400, 0); (500, 1); (600, 2); (700, 3); (800, 4); (900, 5); (1,000, 6); (1,100, 7);
(1,200, 8); (1,300, 9); (1,400, 10); (1,500, 11); and (1,600, 12).
b. The equilibrium value of the exchange rate is the one at which the demand for dollars and the
supply of dollars are equal. The demand for dollars and the supply of dollars both equal 1,200
billion at the exchange rate equal to 8. Therefore, 8 is the equilibrium exchange rate.

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78 Chapter 7 International Trade, Exchange Rates, and Macroeconomic Policy

c. The demand for dollars increases when there is an increase in the demand for American exports or
capital inflows. In this case, the demand for dollars rises due to a large purchase by the Chinese of a
new American-made airplane.
The demand for dollars increases by 300 billion at each exchange rate. Therefore, the points on the
new demand curve are: (3,100, 0); (2,900, 1); (2,700, 2); (2,500, 3); (2,300, 4); (2,100, 5); (1,900,
6); (1,700, 7); (1,500, 8); (1,300, 9); (1,110, 10); (900, 11); and (700, 12).
The equilibrium value of the exchange rate is the one at which the demand for dollars and the
supply of dollars are equal. The increased demand for dollars and the supply of dollars both equal
1,300 billion at the exchange rate equal to 9. Therefore, 9 is the new equilibrium exchange rate.
d. The supply of dollars increases when Americans want to buy more imported goods than there are
capital outflows. In this case, the increase in the supply of dollars is due to a large purchase by
Americans of new lower-priced Chinese-made high-definition TVs.
The supply of dollars increases by 600 billion at each exchange rate. Therefore, the points on the
new supply curve are: (1,000, 0); (1,100, 1); (1,200, 2); (1,300, 3); (1,400, 4); (1,500, 5); (1,600, 6);
(1,700, 7); (1,800, 8); (1,900, 9); (2,000, 10); (2,100, 11); and (2,200, 12).
The equilibrium value of the exchange rate is the one at which the demand for dollars and the
supply of dollars are equal. The demand for dollars and the increased supply of dollars both equal
1,600 billion at the exchange rate equal to 6. Therefore, 6 is the new equilibrium exchange rate.
4. a. A large purchase by Americans of new lower-priced Chinese-made high-definition TVs increases
the supply of dollars. If the Chinese government wishes to maintain the value of the yuan relative to
the dollar at an exchange rate of 8, it must buy up the increased supply of dollars. It particular, it
must buy 600 billion in dollars to maintain equilibrium between the demand for dollars and the
supply of dollars at an exchange rate equal to 8.
b. A large purchase by the Chinese of a new American-made airplane increases the demand for
dollars. If the Chinese government wishes to maintain the value of the yuan relative to the dollar at
an exchange rate of 8, it must increase the supply of dollars to match that increase in demand. It
particular, it must sell 300 billion in dollars to maintain equilibrium between the demand for dollars
and the supply of dollars at an exchange rate equal to 8.
5. a. Capital outflows result from a decline in the interest rate in the United States relative to those in the
rest of the world. That is caused by a fiscal contraction which in this case results from a fall in
defense spending. The demand for dollars decreases by 200 billion at each interest rate. Therefore,
the points on the new demand curve are: (2,600, 0); (2,400, 1); (2,200, 2); (2,000, 3); (1,800, 4);
(1,600, 5); (1,400, 6); (1,200, 7); (1,000, 8); (800, 9); (600, 10); (400, 11); and (200, 12).
The supply of dollars increases by 100 billion at each interest rate. Therefore, the points on the new
supply curve are: (500, 0); (600, 1); (700, 2); (800, 3); (900, 4); (1,000, 5); (1,100, 6); (1,200, 7);
(1,300, 8); (1,400, 9); (1,500, 10); (1,600, 11); and (1,700, 12).
The equilibrium value of the exchange rate is the one at which the demand for dollars and the
supply of dollars are equal. The decreased demand for dollars and the increased supply of dollars
both equal 1,200 billion at the exchange rate equal to 7. Therefore, 7 is the new equilibrium
exchange rate.

©2012 Pearson Education, Inc. Publishing as Addison Wesley

 Answers to Problems in Textbook 79

b. Capital inflows result from a rise in the interest rate in the United States relative to those in the rest
of the world. That is caused by contractionary monetary policy which reduces the money supply.
The demand for dollars increases by 400 billion at each interest rate. Therefore, the points on the
new demand curve are: (3,200, 0); (3,000, 1); (2,800, 2); (2,600, 3); (2,400, 4); (2,200, 5); (2,000,
6); (1,800, 7); (1,600, 8); (1,400, 9); (1,200, 10); (1,000, 11); and (800, 12).
The supply of dollars decreases by 200 billion at each interest rate. Therefore, the points on the new
supply curve are: (200, 0); (300, 1); (400, 2); (500, 3); (600, 4); (700, 5); (800, 6); (900, 7); (1,000,
8); (1,100, 9); (1,200, 10); (1,300, 11); and (1,400, 12).
The equilibrium value of the exchange rate is the one at which the demand for dollars and the
supply of dollars are equal. The increased demand for dollars and the decreased supply of dollars
both equal 1,200 billion at the exchange rate equal to 10. Therefore, 10 is the new equilibrium
exchange rate.
6. a. 9,600 euros.
b. 25.
c. 7,500 euros
d. 32.
e. $300,000.
f. $384,000.
g. The demand curve will be a negatively sloped line joining the points (e = .8euro/$, $ demanded =
300,000) and (e = .625euro/$, $ demanded = 384,000).
h. 240,000 euros.
i. 240,000 euros.
j. The supply curve will be vertical line joining the points (e = 1.60$/euro, euro supplied = 240,000)
and (e = 1.20$/euro, euro supplied = 240,000).
7. a. real exchange rate = 6.0.
b. real exchange rate = 6.6.
c. real exchange rate = 5.45.
d. nominal exchange rate = 5.45.
e. nominal exchange rate = 6.6.
Examples (a), (b), and (c) suggest that, holding the nominal exchange rate constant, the real exchange
rate rises (falls) when the domestic price level rises (falls) relative to the foreign price level. Examples
(a), (d), and (e) suggest that, holding the real exchange rate constant, the nominal exchange rate falls
(rises) when the domestic price level rises (falls) relative to the foreign price level.
8. The implied PPP exchange rate is the ratio of the coffee prices in U.S. dollars times the actual exchange
rate. For example, the implied PPP exchange rate for Javaland is (1.20/1.50)(2.35) = 1.88. The same
calculations reveal that the implied PPP exchange rates for Uppercaffina, Isle of Roast, and Erewhon
are 9.00, 2.97, and 2.61, respectively. The currencies of Uppercaffina and Isle of Roast are overvalued
in terms of PPP since their implied PPP exchange rates exceed their actual exchange rates. The
currencies of Javaland and Erewhon are undervalued in terms of PPP since their implied PPP exchange
rates are less than their actual exchange rates.
9. Nominal exchange rate e should depreciate by 1 percent for PPP to hold.

©2012 Pearson Education, Inc. Publishing as Addison Wesley

80 Chapter 7 International Trade, Exchange Rates, and Macroeconomic Policy

10. a.
1. Given the foreign exchange rate equals 2, net exports equal 870 – 0.08Y – 200(2) =
470 – 0.08Y.
2. In this problem, s = 0.15, t = 0.2, and nx = 0.08, so that the marginal leakage rate equals 0.15(1
– 0.2) + 0.2 + 0.08 = 0.12 + 0.2 + 0.08 = 0.4. Therefore, the multiplier k equals
1/0.4 = 2.5.
3. Ap = Ca – cTa + Ip + G + NXa = 200 – 8r – 0.85(200) + 1,700 – 32r + 1,800 + 470 =
4,000 – 40r.
4. The equation of the IS curve is Y = kAp. Therefore, the equation of the IS curve is
Y = 2.5(4,000 – 40r) = 10,000 – 100r.
5. To obtain the equation for the LM curve, use either Equation (6) on page 118 or set the real
demand for money equal to the real supply of money to get 0.25Y – 25r = 2,250. Adding 25r to
both sides yields 0.25Y = 2,250 + 25r. Dividing both sides by 0.25 provides us with the LM
equation Y = 9,000 + 100r.
6. To compute the equilibrium domestic and foreign interest rates, set the equation for the IS
curve equal to the equation for the LM curve to get 10,000 – 100r = 9,000 + 100r. Adding 100r
to and subtracting 9,000 from both sides yields 200r = 1,000. Dividing both sides by 200 yields
the equilibrium domestic and foreign interest rates r = rf = 5.
7. To compute equilibrium real output, substitute the equilibrium domestic interest rate into the
equations for the IS and LM curves to get Y = 10,000 – 100(5) = 9,000 + 100(5) = 9,500.
b.
1. To obtain the equation for the new LM curve, again use either Equation (6) on page 118 or set
the real demand for money equal to the new real supply of money to get 0.25Y – 25r = 2,200.
Adding 25r to both sides yields 0.25Y = 2,200 + 25r. Dividing both sides by 0.25 provides us
with the LM equation Y = 8,800 + 100r.
2. To compute the new equilibrium domestic interest rate, set the equation for the IS curve equal
to the equation for the new LM curve to get 10,000 – 100r = 8,800 + 100r. Adding 100r to and
subtracting 8,800 from both sides yields 200r = 1,200. Dividing both sides by 200 yields the
new equilibrium domestic interest rate r = 6.
3. To compute the new (temporary) equilibrium real output, substitute the new equilibrium
domestic interest rate into the equations for the IS and LM curves to get Y = 10,000 –
100(6) = 8,800 + 100(6) = 9,400.
4. In a small open economy, the domestic and foreign exchange rates must be equal. That requires
that the domestic interest rate decline to 5 percent. At a 5 percent interest rate, real output
equals 8,800 + 100(5) = 9,300, given the 50 billion decline in the real money supply.
5. For the commodity market to be in equilibrium at an interest rate of 5 percent and real output
equal to 9,300, there must be a 200 billion dollar shift left of the IS curve so that the equation
for the new IS curve is Y = 9,800 – 100r. Given a multiplier of 2.5, the IS curve shifts left by
200 billion dollars if there is an 80 billion dollar decrease in autonomous spending, and
therefore net exports. For net exports to decline by 80 billion, the foreign exchange rate must
rise to 2.4 from 2. (Check: if e = 2.4, NX = 870 – 0.08Y – 200(2.4) = 390 – 0.08Y, Ap = 200 –
8r – 0.85(200) + 1,700 – 32r + 1,800 + 390 = 3,920 – 40r, so that the equation of the new IS
curve is Y = 2.5(3,920 – 40r) = 9,800 – 100r.)

©2012 Pearson Education, Inc. Publishing as Addison Wesley

 Answers to Problems in Textbook 81

c.
1. The equation of the new autonomous planned spending is Ap = 200 – 8r – 0.85(200) +
1,700 – 32r + 1,720 + 470 = 3,920 – 40r.
2. The equation of the new IS curve is Y = 2.5(3920 – 40r) = 9,800 – 100r.
3. To compute the new equilibrium domestic interest rate, set the equation for the new IS curve
equal to the equation for the LM curve to get 9,800 – 100r = 9,000 + 100r. Adding 100r to and
subtracting 9,000 from both sides yields 200r = 800. Dividing both sides by 200 yields the new
equilibrium domestic interest rate r = 4.
4. To compute the new (temporary) equilibrium real output, substitute the new equilibrium
domestic interest rate into the equations for the IS and LM curves to get Y = 9,800 –
100(4) = 9,000 + 100(4) = 9,400.
5. In a small open economy, the domestic and foreign exchange rates must be equal. That requires
that the domestic interest rate increase to 5 percent. At a 5 percent interest rate, real output
equals 9,000 + 100(5) = 9,500, given no change in the real money supply.
6. For the commodity market to be in equilibrium at an interest rate of 5 percent and real output
equal to 9,500, the IS curve must shift right back to its original location. That requires that
autonomous spending, and therefore net exports, must rise by 80 billion, the amount of the
decrease in government spending. For net exports to increase by 80 billion, the foreign
exchange rate must fall from 2 to 1.6. (Check: if e = 1.6, NX = 870 – 0.08Y – 200(1.6) = 550 –
0.08Y, Ap = 200 – 8r – 0.85(200) + 1,700 – 32r + 1,720 + 550 = 4,000 – 40r, so that the
equation of the IS curve is Y = 2.5(4,000 – 40r) = 10,000 – 100r.)
d. Parts b and c show that monetary policy is very potent in a small open economy with a flexible
exchange rate system, whereas fiscal policy can have only a temporary impact on real output in
such an economy.

©2012 Pearson Education, Inc. Publishing as Addison Wesley

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 From the opposite side came a different cry:
“He’s your meat, Lefty! Get him, and it’s all over! Don’t lose him,
on your life!”
It was to be the great test. A clean hit would leave Hoover still
supreme in the league; a strike-out would place another far above
him. The lips of the Bully at bat curled back from his teeth, and he
stood there ready, like a man made of steel springs. With a sort of
placid grimness, Locke swung into his delivery.
Hoover fouled the first one into the bleachers.
“Strike!”
“That’s one on him!”
“You’ve got him coming, Lefty!”
“He can’t hit you!”
“You can’t let him hit!”
“Do it again!”
Hoover stamped his spikes into the ground, rooting himself, that
the hit might be effective when he landed on the ball. He had felt of
the first one; he would straighten the next one out. In fancy, he saw
himself cantering over the sacks, with the runners ahead of him
scoring, and the Bancrofters splitting their throats. Doubtless a two-
bagger would score all three of the runners; and then, even if he did
not reach the rubber himself, he would go out there and hold the
“Kinks” runless in the last of the ninth. He knew he could do it.
“Ball-l-l!”
Jock sneered at Locke’s teaser. What a chump the fellow was to
think he would reach for anything like that!
“Put one over!” he invited. “You don’t dare!”
It came—whistling, high, and taking an inward shoot. Hoover did
not graze the horsehide.
“Strike tuh!”
 That set the Kingsbridgers off again:
“Get him, Lefty—get him!”
“Oh, you, Lefty!”
“You’re the stuff, old boy!”
“Sic him, you wiz!”
“Mow him down!”
“Polish him off!”
“End his suffering, Lefty!”
“Oh, you, Lefty! Oh, you, Lefty!”
Hoover’s teeth were grinding together like millstones. Although
angered by his failure, he still gripped and held his confidence that
he could hit Locke at this time when a hit meant so much; for, as a
pinch hitter, he had an enviable record.
Another shoot came over. Jock hit it. But again the ball went into
the bleachers, causing the umpire to stop the base runners with a
bellow:
“Foul!”
“That’s the best he can do, Lefty! He’s going! He’s almost gone!”
There was a delay. Some one had pocketed the ball, and
presently a spotless, fresh one was tossed out to Locke.
“Where’ll that one go when he hits it?” yelled a Bancrofter.
“When he hits it!” mocked a Kingsbridger. “He never will!”
Leaning forward to get Oulds’ signal, Locke gave his head a
shake. The sign for a drop was instantly changed to one calling for
an inshoot, and the young pitcher lost no time.
There was a white streak in the air, and the ball almost seemed to
twist round Hoover’s neck, slightly grazing the bat close to his
knuckles as he swung. Into Oulds’ big mitt it plunked.
 “Y’re out!” was the cry of the umpire, as he flung his hand upward
above his head.
Instantly Hoover called Tom Locke a vile name, and sent the bat,
with all the strength of his quivering, muscular arms, spinning
straight at the pitcher’s head.
 CHAPTER XIV
AFTER THE GAME

T he indescribable uproar which greeted the strike-out that settled

the game prevented Hoover’s words from reaching Locke’s ears,
but the glare in his eyes, the expression of his face, and the
movement of his lips told well enough what he said. The triumphant
pitcher barely avoided the whistling bat by an agile side spring. In
another instant, his face went white; he was coming at Hoover with a
rush.
Tense with excitement, Janet Harting saw it all; she saw the
steady, youthful, almost boyish, Kingsbridge pitcher fool the Caliban-
faced Bully for the final fruitless slash which settled the game, two to
nothing, in the home team’s favor; saw Hoover, snarling, hurl the bat;
and then beheld a swirling rush of shouting, wrathy human beings,
who smashed the restraining rails in front of the bleachers, and
poured upon the field like a spring flood from a bursted reservoir.
“I think,” said Benton King, gathering the reins, “that it is time for
me to take you away from here, Janet.”
Trembling, she grasped his arm. “No, no!” she cried. “What are
they going to do? That wretch threw his bat at—at Lefty.”
“Yes; and he’ll get his, if his friends don’t look out for him well.
Locke has got all Kingsbridge behind him, and they’re a tough bunch
when they get good and mad. There’s likely to be some broken
heads.”
“Oh, wait a moment!” she entreated. “Look! They’re trying to hold
the crowd off, and I believe Lefty is helping them.”
Out there on the diamond, raging, frothing men were shaking their
fists at the offending pitcher; while others, including a number of
Kingsbridge players, having packed themselves round the
threatened man, were holding the hot-heads back by main force.
And it was true that Tom Locke was one of those who sought to
protect Jock Hoover from the wolfish mob.
“Stop!” his voice rang out, clear and distinct. “Keep back! The
trouble is between that man and me. We’ll settle it.”
“Let-a me git at-a him!” raged an Italian, the same who had
amused the crowd after the striking out of Mace in the first inning, by
asking what was the matter with Lefty. “He throw-a da bat! I knock-a
da block off-a da sneak-a!”
His cigar gone, his hat smashed, his collar torn awry, Mike Riley
succeeded in reaching Hoover.
“You infernal idiot!” he puffed. “Didn’t you know better? What made
ye do it?”
“Bah!” retorted Jock with contempt and courage worthy of a better
cause. “These barking curs won’t do anything. Give me a show, and
I’ll break that left-handed dub’s face. He hasn’t got the courage to
give me an opportunity right now—here. He’s a——” The concluding
epithet was a repetition of the insult he had hurled at Locke along
with the bat.
“No man can swallow that!” muttered Larry Stark. “Somebody
must fight that miserable rowdy.”
“Give me the chance,” said Tom Locke, “and give him the same
even show, without interference. Let the crowd keep back.” They
marveled at his calmness.
Some of Hoover’s friends sought to rush him off, against his will,
and the vociferous, twisting, lunging mass of humanity swept over to
one side of the diamond, where Bent King had his hands full in the
task of restraining his fretting span from plunging forward and
trampling some of them. King had listened to Janet’s appeal, and
dallied a few moments too long; now they were caught in the midst
of the mob that packed close on all sides. Two men, taking note of
his difficulty, grasped the horses by the bits; but the crowd,
seemingly deaf and oblivious to everything except the imminent fist
fight, could not be induced to make way.
 “I’m sorry, Janet,” said the lumberman’s son. “This is no place for
you. I was a fool to wait a minute when the trouble began.”
“Never mind,” she returned, her voice quivering a little, her face
quite colorless. “I—I want to see. It isn’t right for them to fight; it isn’t
fair. Lefty can’t be a match for that ruffian. Why don’t they stop it?”
Not much time was wasted in preparation when it was understood
that Locke was ready to meet his challenger. Members of the two
teams began pushing the crowd back to make room, begging them
to give the men a chance, and a fifteen-foot space was finally
cleared. Eager spectators climbed upon the shoulders of those in
front of them; the bleachers, at one end, were loaded to the cracking
point with human beings; and every stout limb of a near-by tree
quickly bore human fruit.
Bareheaded, the men met in the center of the cleared space.
Hoover came with a rush, and Locke was not dilatory. Plainly the
Bully weighed ten or fifteen pounds more than his slender
antagonist, and many a sympathizer with the youth feared the match
must prove to be pitifully one-sided.
Jock led, right and left; but the youngster parried, blocked, and
countered like lightning, closing in without hesitation. His jaw was
set, and he was still cool, while the Bancrofter blazed with all the fury
of a conflagration.
The sound of thudding blows caused Janet Harting to drop her
parasol, which she had closed; her hands went up to her heart, and
her lips were parted that she might breathe, the open air seeming
close and smothery.
 CHAPTER XV
MAN TO MAN

I t was a scene to be printed indelibly on the memory: The palpitant,

swaying crowd, those in front pushed forward by those behind; the
baseball players round the edges of the cleared space, bracing to
hold the mob back almost by main strength; human beings climbing
on other human beings to get a momentary glimpse of the fighters;
men and boys jammed in a dense mass on the bleachers, and still
more of them clinging like monkeys to the bending limbs of the tree
—and every face ablaze with the primitive passion of mankind, the
savage zest of battle, the barbarous joy of witnessing a sanguinary
struggle between two of their specie.
But Janet saw only the fighters; not for a moment did her straining
eyes waver or wander. She watched them leap and retreat, meet
again, stagger, recover, sway this way and that, all the time turning
round and round to the left or to the right, their arms flashing out,
their battering fists giving forth sounds now sharp, now sodden, as
they smashed on head or body. She saw the head of the brown-
haired youth jerk backward before a blow full on the mouth; and
then, as blood stained his lips, a cry—half snarl, half roar—broke
from the crowd.
Hoover had drawn first blood, seeing which, an expression of
malicious joy contorted his repellent face, and he seemed spurred to
still fiercer efforts. He thirsted to leave the stamp of his fists indelibly
recorded on that clean-cut face; to mark the youth for life would be
an exquisite pleasure, lingering long in aftertaste.
Locke, however, continued to keep his head, improving such
openings as he could find or make. A cut lip was of no consequence
when he had not felt the blow much; but he must take care that his
antagonist did not reach his jaw with a swing like that, having a bit
more steam behind it. And he must husband his energy and bide his
time, for this was no fight by rounds, and Hoover had set a pace
which flesh and blood could not keep up protractedly. In time, he
must weary and slacken, and Locke hoped to be ready to make the
most of it when this faltering came.
The youth’s left-handed guard bothered Jock somewhat, causing
him to fret and snarl. Twice he pinned Locke up against the crowd,
that could not make room for his free movement; but once Tom got
under his arm and away, and once he met the aggressor with such a
sudden storm of blows that Hoover was checked and driven back.
After that both men were bleeding, the Bully having received a stiff
smash on the nose.
The crowd shouted applause and instruction:
“Fine work, Lefty!”
“Keep after him, Jock! Put him out!”
“You’ve got him going! Follow him up!”
“Look out for his left, boy!”
“Soak him another in the same place—that’s the stuff!”
“Well,” said Bent King, in wonderment, “I’ll be hanged if Locke isn’t
holding his own with that terrier!”
Apparently Janet did not hear him. A little color had risen into her
cheeks, and her bosom was heaving against her tightly clenched
hands. She was still fearful of the final result, but he with whom her
throbbing heart sympathized had met his brutal enemy like a man of
courage, and made it a worthy battle. She could hear Hoover
breathing heavily, like one on whom the tremendous strain was
beginning to tell at last, while Locke, although his breast rose and fell
rapidly, was, to all outward seeming, the fresher of the two.
Once a little, choking gasp escaped her, for the youth was sent
reeling by a blow, Jock rushing forward to follow it up. Locke,
however, kept his feet with the agility of a cat, avoiding that rush, and
getting in a body punch that made the other man grunt.
 Following this, discovering at last the drain his efforts were putting
upon him, Hoover sought to take it easier, and recuperate. This
quickly became apparent, and a cry arose:
“He’s stalling, Lefty! Go to him! Don’t let him get his wind back!”
Locke had no intention of permitting his antagonist to rest, and
now he took the aggressive, and kept at it with persistence that wore
on Hoover.
Up to this point, Mike Riley had entertained no doubt as to what
the end must be, but now uncertainty seized him, followed by alarm
as he beheld tokens which seemed to denote that Hoover was
becoming a bit groggy.
The Bancroft manager had no wish to see his puissant slabman
whipped, for that would leave him no longer the terror he had been
to opposing batsmen; and much of his success as a pitcher had
doubtless come through the awe which he had inspired.
“Hey!” croaked Riley suddenly. “I guess this here’s gone ’bout fur
enough.”
But, with his first movement to interfere, he was seized by more
than one pair of hands, jerked back, and held.
“Guess again!” cried Larry Stark. “Hoover forced it on the boy, and
now he’ll have to take his medicine.”
“That’s right! That’s right!” shouted half a hundred voices.
“You bet it’s right!” roared a big millman in the crowd. “If this
Bancroft bunch tries to meddle now in a square fight, they’ll have the
whole o’ Kingsbridge on top of ’em.”
Possibly a free-for-all fight might have broken out at this point, but
suddenly Tom Locke’s fist fell on Hoover’s jaw with a crack like a
pistol report, and the Bancroft pitcher’s legs seemed to melt beneath
him.
Prone upon the trampled ground he sank in a huddled heap, while
Locke, lowering his hands at his sides, stepped back and stood
looking down at him. A hush came over the crowd. The fallen man
made a blind, feeble effort to lift himself, turned his body partly, then
slumped back, his face in the turf, and lay still.
“He’s put Jock out!” said some one in an awed and marveling
voice.
With a yell, Larry Stark leaped forward and seized the victor’s
hand. That yell was echoed by the mob.
“Lefty did it!”
“Oh, you, Lefty! Oh, you, Lefty!”
Locke’s face was sober and unsmiling, betraying no elation.
Satisfied that it was really over, he lifted his eyes, and found himself
unexpectedly gazing into the wide blue eyes of a girl who was
looking down at him from a carriage round which the crowd was
wedged. For a moment they stared at each other, while the cheering
continued, and slowly a flush of shame mounted into Tom Locke’s
cheeks. He turned away.
“Come, Bent,” said Janet in a husky voice, “can’t we get out of
here now? I’m really faint. Please hurry.”
 CHAPTER XVI
BENTON KING AWAKENS

J anet was pale and silent as King drove into town. Glancing at her,
he saw that her lips were pressed together, her smooth brow
puckered a bit, and her eyes filled with a strange, thoughtful
expression. Her hands tightly gripped the handle of her parasol.
“I’m sorry it happened that way, Janet,” he said apologetically. “It
was thoughtless of me to get caught in that mob, so that you were
compelled to suffer the humiliation of witnessing such a brutal
spectacle.”
“You were not to blame,” she returned, in a low, queer voice. “I
begged you to wait. I’m glad I did.”
“You’re what—glad?” he exclaimed, astonished. “It was not a thing
for a girl like you to see and hear.”
“Still,” she declared, “I am glad I saw it. I know now that any man
with an atom of manhood in his make-up may sometimes be
compelled to fight.”
“That’s right,” he agreed, “and he can’t always pick a gentleman,
or a man of his own class, for an antagonist.”
She looked at him quickly. “Do you think Tom Locke is a
gentleman?”
“Oh, I don’t know about that; it’s doubtful, considering the
company he’s with.”
“Do gentlemen never play baseball?”
“Certainly—in college games.”
“But they never play professionally?”
 “I wouldn’t say that, you know,” was his slow answer. “Some
college men go in for professional baseball after graduating. Almost
always, they need the money to give them a start in some chosen
profession or business. But not all college players are gentlemen, by
any means; far from it. At Harvard, even though baseball and football
players and members of the track team were decidedly popular in a
general way, there were none of them in my set, and I didn’t see fit to
associate with them much.”
Even as he said it, he flushed a bit, knowing she, like many others
in Kingsbridge, must be fully aware of the fact that his exasperated
father had removed him from Harvard in his sophomore year to
avoid the disgrace of his suspension, or possible expulsion, because
of certain wild escapades in which he had been concerned, along
with some others of his own particularly swift set. Nevertheless, he
had his standards of deportment and qualifications essential to the
gentleman, though, doubtless, it would be no easy matter to make
them clear to some strait-laced, narrow-minded persons.
He was nettled by the conviction that Janet was suddenly taking
altogether too much interest in the practically unknown Kingsbridge
pitcher, who, following his surprising double victory of the day, was
surely destined to become a popular idol in the town. He had known
Janet three years, having met her at a church sociable in the days
when Cyrus King was setting about in earnest, by the construction of
his mills, to turn Kingsbridge from a dull, sleepy settlement into a
hustling, chesty town. At first she had seemed to be an unusually
pretty, vivacious little girl, with somewhat more refinement and good
sense than the usual run of country maidens; but that he would ever
become genuinely and deeply interested in her had not occurred to
him as a remote possibility. Even after he had left college and begun
work in the big sawmill, although he found her much matured and
developed, and therefore still more interesting, he but slowly came to
realize that she was the possessor of some potent charm, indefinite,
elusive, indescribable, which was casting a powerful spell over him.
Not until this day, however, had he realized how firmly this spell
had gripped him. It had come upon him as a surprise which he
obstinately tried to misinterpret; for why should he, the only son and
heir of old Cy King, several times over a millionaire, permit himself to
be bewitched past self-mastery by this little country girl, daughter of
a broken-down village parson, who had not tried to bewitch him at
all? It seemed ridiculous, something to demand self-reproach; for,
least of all, when he thought of such a thing, which was rarely, had
he fancied himself silly enough to be caught in such a net. Moreover,
he knew what stormy anger the knowledge would produce in his
father if the knowledge ever came to him.
The truth had stabbed him there upon the baseball field. It had
taken the piercing form of a jealous pang, which he had sought to
conceal when he saw that Janet was becoming interested in the new
Kingsbridge pitcher; and it cut deeper and deeper as her interest
grew and developed into out-spoken admiration. He had seen her
watching that fierce fist fight, knowing all the while that she was
praying that Locke might conquer, and, though she had held herself
marvelously in hand, he seemed to fathom all the torture and dread
which filled her heart. That she should care so much what might
happen to a total stranger, even though he were the new-found idol
of the Kingsbridge fans, was sufficient to skim the scales swiftly from
Benton King’s eyes, and leave him confessing to himself, without
shame, that she was very dear to him. For, trite but true, that which
we desire very much becomes a thousand times more desirable as
our chance of possession grows less.
And now, as they drove slowly homeward, something writhed and
burned within him at the further evidence of her interest in Locke. He
was tempted to speak up boldly and say that there was not one
chance in a million that the fellow could be a gentleman; but he had
not yet lost his head, even if his heart was gone, and he had sense
enough to know that such a course might be the most unwise one he
could pursue. So he held himself in check, registering an inward vow
that he would see to it that this fellow Locke found as little chance as
might be to give him worriment over Janet.
Too soon the little parsonage, a modest story-and-a-half house,
one of the oldest in Kingsbridge, came into view. Too soon they were
at the door, and he was helping her to alight. He held her hand to the
extreme limit of good taste, held it and pressed it, saying:
 “I shall be at church to-morrow. If you don’t mind, it would give me
pleasure to escort you home after the services.”
She looked at him in surprise, her lips parted in an odd little smile,
her violet eyes emphasizing her wonderment.
“Why, Bent, you’ve scarcely attended church half a dozen times
since you came home from college. What brings you out to-
morrow?”
“You!” he answered, feeling himself thrill and choke a bit. “I’m a
heathen, I admit; but I’m coming out to-morrow to worship—you.” He
had said such things before, to other girls, but he had spoken them
lightly, and without a tremor; now little electric vibrations were
running along his nerves, and, though he knew that his face was
pale, he could feel his swollen heart pulsing hard, and his temples
drumming. He had never dreamed that saying such a “little thing” to
a pretty girl would come so near unmanning him.
Her surprise had grown, but she was self-possessed. “Thou shalt
not worship false gods,” she laughed. Then, as if she saw something
in his eyes which made her fear he would go further, she hastily
gave her consent: “If you come out to church to-morrow I’ll permit
you to walk home with me—after Sabbath School. That’ll be your
reward for listening to father’s sermon. Now, for the first time in my
life, I feel that I have really done something for the heathen.”
Laughing, she ran up the steps of the trellised porch, turning a
moment to say good night, framed in an arch of June green vines.
Head bared, he gazed at that picture, and found it the fairest his
eyes had ever looked upon. There was now in his mind no question,
no doubt; he knew.
“Good night, Janet,” he said softly. “Until to-morrow, and that will
be—a year.” He had laughed at silly, lovesick chaps who said things
like that; but now, before he knew what he was saying, he had
uttered it with all the sincerity of his soul.
 CHAPTER XVII
FATHER AND DAUGHTER

T he door of the Reverend John Harting’s study was open. In the

softened afternoon light which came from the window above his
desk, he sat, giving his morrow’s sermon the last polishing touches.
But when Janet would have slipped past, he heard her light footstep,
and called to her. She stopped at the door.
“Come in, my dear,” he said, lifting his spectacles to his forehead,
and turning from the outspread pages of manuscript. “Would you
mind sitting down a moment? I have something I wish to say to you.”
He spoke precisely and formally, and even in ordinary
conversation he had a touch of that singsong intonation which all
old-time ministers affected. A fringe of white locks, carefully combed,
added to the somewhat stern, but almost patriarchal, expression of
his angular, deeply lined face. It was the fearless face of a good-
hearted man, and yet there was something about it indicative of
narrowness and bigotry. Such a face, one fancied, might have
belonged to a leader of martyrs.
She came to him, and sat upon the arm of his chair, encircling his
neck, and patting his cheek.
“Now, father, dear,” she laughed coaxingly, “I hope you’re not
going to scold. I know you didn’t want me to go to the ball game, but
I was just dying to go, and Benton invited me, and—”
“He came round here, and cajoled me into consenting, against my
will. He is a young man with a most persuasive and flattering
tongue.”
“I’ll not dispute you,” she said, thinking of those parting words at
the door. “He needed a persuasive tongue to win you over, you are
so dreadfully set against baseball. You can’t seem to realize that the
game itself is really harmless and clean, and two-thirds of the people
of this town are crazy over it. They’ll be crazier still after to-day, for
we beat Bancroft—shut ’em out without a single tally, gave ’em nine
beautiful goose eggs. What do you think of that, father?”
He looked a bit puzzled. “What have goose eggs to do with
baseball, my dear?”
“Oh,” she laughed, “I mean to say that we handed them a beautiful
coat of whitewash, and we bingled out a couple of merit marks for
ourselves. The crowd just went crazy when our new southpaw slant
artist started the fireworks going in the sixth with a clean wallop,
moved up a peg on a sacrifice, pilfered the third hassock, and slid
home on a beautiful squeeze that gave us our first count, and—”
“Stop, Janet!” he cried, bewildered. “What are you talking about?”
“Why, baseball, daddy! I’m simply telling you how we won the
game.”
“You may be trying to tell me, but you are not doing it simply. ‘Coat
of whitewash,’ ‘bingle,’ ‘southpaw slant artist,’ ‘clean wallop,’ ‘third
hassock,’ ‘beautiful squeeze’! My dear, it’s dreadful for a young lady
to use such language. It is ample evidence of the absolutely
demoralizing influence of this game called baseball.”
She laughed still more gayly, and again patted his cheek
caressingly. “That’s simply the idiom of the game, which every true
fan understands.”
“But you should remember that I am not a true fan, whatever that
may mean. I abhor slang, especially from the lips of a refined girl.
You know my efforts alone last year prevented the desecration of the
Sabbath by this dreadful game, which seems to turn people’s heads,
and is productive of untold strife and bitterness. What will be thought
now when my daughter is seen attending these games?”
“But they are not playing Sunday baseball, daddy, and I agree that
you were quite right in bringing your influence to bear against that,
though, as I said before, I hold that there is no harm in the game
itself.”
 “There is harm in whatever produces harm, which is sufficient
answer to your argument. And look at the class of men who take part
in those games. Would you be proud to associate with them? Would
you choose them as friends?”
“No,” she confessed; “not many of them; but still there are some
really decent ones who play. Larry Stark is one. I know him, and I’m
not ashamed of it.”
“There may be an occasional exception, but you know the old
saying that exceptions prove the rule. Once in a while a respectable
young man may be led by necessity to make a business of baseball,
but I am sure no such young man will long continue to follow it up.”
“Respectable people watch the games. Some of the best people in
Kingsbridge were there to-day.”
“Which denotes a deplorable tendency of the times. And you must
not forget that this town has changed from a peaceful country
settlement to a place that is rough and crude, and filled with
viciousness and vice. I am having a struggle against these evil
influences, and I need the moral support of my daughter’s example,
at least. If your mother had lived—”
“Now, father, please don’t! You seem to have an idea that I’m a
most reckless, wicked young person, and you always use that form
of argument to shame me in my sinful ways. I saw in the grand stand
to-day several of the most respectable ladies in town, at least two of
whom are regular attendants at your church.”
“Some seed must fall on barren ground. I hope young King will not
ask you to go with him again. If he comes to me, I shall refuse my
consent; if you go, you will do so against my wishes.”
With him in this inflexible mood, she knew the uselessness of
persuasion or cajolery, and she left him, to run up to her room a few
moments before the maid should call them to tea. Removing her hat
before the mirror, she pouted a little at the charming reflection in the
glass.
“Father is so set,” she murmured; “yet I’ve always been able to
bring him round some way, and I must do it about this; for I just can’t
stay away from the games. I guess I’m a real fan, all right, and I’ll be
worse than ever with Kingsbridge winning from Bancroft, and—and
Lefty pitching. He’s surely what they can call some pitcher. And he
can fight—gracious!”
She shivered a bit at the recollection of the scene she had
witnessed after the game was over. Again she seemed to behold
those fighting men hammering at each other with their bare fists,
savage, bloodstained, brutal. She shuddered at the remembered
glare of their eyes, the wheezing of their panted breathing, and the
crushing sound of their blows. From her parted lips came a little
gasp, as once more on her ears seemed to fall the clear crack of
Tom Locke’s fist smiting his foe full on the point of the jaw with such
force that Hoover’s legs had given way beneath him like props of
straw.
“He can pitch, and he can fight,” she whispered. “He looks clean
and manly, too. I wonder what he’s really like. I suppose he must be
coarse and vulgar. When father hears about that affair, he’ll be far
more set against the game than ever, and he’s sure to hear, for the
whole town must be talking of it now.”
While she made her toilet for tea, the clean-cut, determined face of
the young pitcher seemed to haunt her. Vexed by this, she decided
to put him resolutely out of her mind.
“I’m like a silly schoolgirl, seeking a hero to worship,” she laughed,
blushing at her folly. “I’m old enough to know better. Such heroes
always have feet of clay. Still, I’d like to think of him as well as I can
—as a pitcher; and, to do so, it is wise that I should view him from
afar, that his flaws may not be too apparent. I’ll take care about that.”
Then her thoughts turned to Benton King, and a little frown
gathered upon her face. To-day, as they were driving homeward, and
especially as they were saying good night at the door, there had
been something in his manner and his words that he had never
before unveiled to her. Hitherto they had been just good friends—he
deferential, in a way—yet free and easy, as such friends might be,
with no self-consciousness or constraint; but now, after this,
something warned her that it would be changed, even though, as
she believed, he had been neither deep nor sincere in what he had
felt or said.
“I’m sorry,” she murmured, still frowning; “for I like Bent, and he’s
about the only young man in Kingsbridge I’d care to be really friendly
with. I suppose it’s been so long since he’s had an opportunity to talk
such nonsense to a girl that he just had to try it on some one to keep
in practice. But I don’t like it, and I’ll have to stop it. Next time he tries
it, I’ll chaff him till he quits. I’ll tell him I like Lefty.”
She could not have chosen a more certain method of preventing
Benton King from quitting.
 CHAPTER XVIII
THE GREEN-EYED MONSTER

T he sermon was dry and tiresome, old-fashioned and overflowing

with “doctrine.” John Harting had never made a pretense of
sympathizing with the liberality of modern dominies who relied wholly
for the saving of souls upon “the message of love.” True, he had
ceased openly to preach “hell fire,” but doubtless he still believed in
it, if not as a literal punishment for the sinful hereafter, then as the
only adequate synonym of the penalty that should be meted out to
the evil-doer who died unregenerate.
He had found that such preaching, instead of attracting and
holding congregations, left the pews of the little old church sadly
vacant; and the effort to modify his sermons had taken from them the
little heart they once possessed, and made them wearisome and
soporific.
The day was warm and sunny, and at times faint little grateful
breezes, venturing in at the open windows, brought the June odors
of flowers, and grass, and green growing things. Birds were singing
in the trees which shaded the church, and away out yonder the river
smiled, and the woods beckoned one to cool shadows and mossy
glades.
Thoughts of those glades and shadows occupied Janet in her pew
far more than thoughts of the sermon. But those were not by any
means her only thoughts; once or twice she had ventured an
admirably careless and unstudied glance in the direction of two
young men who were sitting far over at the side of the church, both
of whom were maintaining a commendable and heroic mien of strict
attention to the words of the parson.
It was not, however, Larry Stark who had drawn her glances; her
eyes had been directed toward the clear profile of Larry’s pewmate,