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PS 2

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21 views5 pages

PS 2

Uploaded by

iosonocetinkaya
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PS-2

1)Use the money market and FX diagrams to answer the following questions about the
relationship between the British pound (£) and the U.S. dollar ($). The exchange rate is in U.S.
dollars per British pound, E$/£. We want to consider how a change in the U.S. money supply
affects interest rates and exchange rates. On all graphs, label the initial equilibrium point A.

a. Illustrate how a temporary increase in the U.S. money supply affects the money and FX
markets. Label your short-run equilibrium point B and your long-run equilibrium point C.
Answer: See the diagram below.

b. Using your diagram from (a), state how each of the following variables changes in the short
run (increase/decrease/no change): U.S. interest rate, British interest rate, E$/£, Ee$/£, and the U.S.
price level P.
Answer: The U.S. interest rate decreases, the British interest rate does not change, E$/£ increases,
Ee$/£ does not change, and the U.S. price level does not change.
c. Using your diagram from (a), state how each of the following variables changes in the long run
(increase/decrease/no change relative to their initial values at point A): U.S. interest rate, British
interest rate, E$/£, Ee$/£, and U.S. price level P.
Answer: All of the variables return to their initial values in the long run. This is because the shock
is temporary, implying the central bank will increase the money supply from M2 to M1 in the long
run.
2) Use the foreign exchange and money market diagrams to answer the following questions about
the relationship between the Indian rupee (INR) and the Chinese yuan (CNY). Let the exchange rate
be defined as rupees per yuan EINR/CNY. Suppose there is a fall in the Indian nominal money supply.
Make the usual assumptions: UIP holds, PPP holds in the long run, prices are sticky in the short run,

a. Assume first that the fall in money supply is temporary (so that the nominal money supply is put
back at its original level in the long run). Illustrate the effects of this in a pair of graphs, one for the
Indian money market and one for the foreign exchange market. Label the initial equilibrium as point
A, the short-run equilibrium point B, and your long-run equilibrium point C.

b. Now assume instead that the fall in money supply is permanent. Illustrate this in a pair of graphs,
one for the Indian money market and one for the foreign exchange market. Label the initial
equilibrium as point A, the short-run equilibrium point B and your long-run equilibrium point C.
c. Does the theory of “exchange rate overshooting” apply to the case in part (a) above? How about to
the case in parts (b) and (c)? Explain the economic reason the two cases are different.

Overshooting does not apply to the temporary case, that is, the exchange rate in the short run does not
move more than in the long run. This is because there is no shift in expectations about the future
exchange rate to amplify the movement in the current exchange rate. This only occurs in the
permanent case.

3) The following table contains the U.S. totals for key international transactions in 2008, in billions of dollars.

Line (Credits +; debits -)

2 Exports of goods and services +$1,827

12 Income receipts +765

19 Imports of goods and services -2,523

29 Income payments -646

35 Unilateral current transfers, net -128

39 Capital account transactions, net +1

Financial Outflows:

41 U.S. official reserve assets -5

46 U.S. government assets, other than official reserve assets -530

50 U.S. private assets, net +534

Financial Inflows:

56 Foreign official reserve assets in the U.S. +487

63 Other foreign assets in the U.S. +47

a) Calculate the Balance on Current Account, and the Statistical Discrepancy.

CA = -705$

SD= +171$

b) Calculate the Official Settlements Balance.

Official Settlements Balance: +487 + (-5) = +482

c) In 2008, U.S. GDP was $14,441 billion. How much was Gross National Expenditure? How much was Gross
National Disposable Income?

GDP – TB = GNE

TB= 1827-2523= -696

GNE = 14441-(-696)
GNE = 15137

GNDI = GNE+CA = 14432

4) (Table: Hypothetical U.S. National Income and Product Accounts Data) Using the table,
the GNE is:

a) GNE is: 11,400


b) Trade Balance is : -850
c) GDP : 10,550

5)Consider the economy of Opulenza. In Opulenza, domestic investment of $400 million earned
$15 million in capital gains during 2009. Opulenzans purchased $160 million in new foreign
assets during the year; foreigners purchased $120 million in Opulenzan assets. Assume the
valuation effects total $5 million in capital gains.
N.B. We need to assume a value for the capital account. We will assume KA = 0 in the following
transactions.
a. Compute the change in domestic wealth in Opulenza.

Answer: The change in domestic wealth is the sum of additions to the capital stock plus capital
gains earned on domestic assets:
Change in domestic wealth = I + Capital gains on K = $400 + $15 = $415 million

b. Compute the change in external wealth for Opulenza.

Answer: The change in external wealth is: ΔW = Valuation effects + (−FA) = $5 − ($120 − $160) =
$45 million

c. Compute the total change in wealth for Opulenza.

Answer: The change in total wealth is:


Change in total wealth = Change in domestic wealth +
Change in external wealth = $415 + ($45) = $460 million

d. Compute Opulenza’s current account. Is the CA in deficit or surplus?


Answer: Using the current account identity S = I + CA:
S = I + CA
$440 = $400 + CA, CA = $40 million
6) Show how each of the following would affect the U.S. balance of payments. Include a
description of the debit and credit items, and in each case identify which specific account is
affected (e.g., imports of goods and services, IM; exports of assets, EXA; and so on).

a) The U.S. government forgives a $50 million debt owed by a developing country.

Description BOP Account Account (detail) Credit/Debit


Debt forgiveness KA (↓) −KAOUT (↑) −$50 million
(gift)
Decrease in external FA (↑) −IMFA (↓) +$50 million
assets owned by U.S.
entities

b) U.S. owner of Sony shares receives $10,000 in dividend payments, which are paid into a
Tokyo bank.

Description BOP Account Account (detail) Credit/Debit


Export of factor CA (↑) +EXFS (↑), NFIA (↑) +$10,000
service (ownership)
to ROW
Japanese deposits FA (↓) −IMFA (↑) −$10,000
owned by U.S. to
ROW

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