ECF2721 SAMPLE EXAM Q&A 1
Use the following to answer questions 1 - 3.
Consider Country A who uses dollars as the currency of the country. The country had only the following international transactions in 2019.
An exporter of Country A sold 10 million dollars’ worth of goods to U.S.A. With the receipt of 10 million dollars, the exporter purchased the U.S. treasury bonds.
Q1
What is the current account balance (in million dollars) of Country A in 2019 (zero decimal places)?
Q2
What is the financial account balance (in million dollars) of Country A in 2019 (zero decimal places)?
Q3
If the valuation effects were 5 million dollars for the external wealth of Country A in 2019, what is the change of the external wealth (in million dollars) of Country A in 2019 (zero decimal places)?
Use the following hypothetical national income and product accounts data (billions of dollars) in 2017 to answer questions 4 - 6.
. Consumption (personal consumption expenditures): 50
. Investment (gross private domestic investment): 10
. Government consumption (government expenditures): 20
. Net exports of goods and services: -10
. Net factor income from abroad: -15
. Net unilateral transfers: 10
. Capital account balance: 5
. Statistical discrepancy: 0
. The external wealth at the beginning of 2017: 500
. The external wealth at the end of 2017: 480
Q4
What is the Gross National Income (in billion dollars) of the country in 2017 (zero decimal places)?
Q5
What is the current account balance (in billion dollars) of the country in 2017 (zero decimal places)?
Q6
What is the financial account balance (in billion dollars) of the country in 2017 (zero decimal places)?
Use the following information to answer questions 7 - 9.
Use the money market with the general monetary model, and foreign exchange (FX) market to answer the following questions.
Consider 2 countries, country A (using dollars) and B (using pounds). In Country A, the money supply, M(A), is 200 million dollars, the real income, Y(A), is 200 million, the the price level P(A), is 2 dollars, and the annual nominal interest rate, i(A), is 5 percent. In Country B, the money supply, M(B), is 100 million pounds, the real income, Y(B), is 200 million, the the price level, P(B), is 1 pound, and the annual nominal interest rate, i(B), is 5 percent. These two countries have maintained the long-run levels with the nominal exchange rate E(A/B) of 2.00. Assume that both countries have perfect capital mobility. Note that the uncovered interest parity (UIP) holds all the time and the purchasing power parity (PPP) holds only in the long-run. Assume that the new long-run levels are achieved within 1 year from any permanent changes in the economies.
Now, today at time T, the real income of Country A fell by 3% permanently. With the fall of the real income in Country A, the annual nominal interest rate in Country A fell by 2 percentage points, from 5% to 3% today. Unless otherwise noted, assume that the money supply in Country A, the real income in Country B, and the money supply in Country B, do not change at all. Treat Country A as the home country. In answering the questions use the exchange rate defined as the units of country A's currency per 1 unit of country B's currency, E(A/B). Assume that both countries use the floating exchange rate system in answering questions 7 and 8.
Q7
Using the exact equation of the uncovered interest parity, calculate the exchange rate, E(A/B), today after the permanent fall of the real income of Country A (two decimal places).
Q8
Explain (in words) how this change affects the money market in Country A and the FX market in the short-run, and in the long-run.
For the short-run equilibrium, be sure to state the movements (shifts) of all curves (MD and MS
curves in Country A, DR and FR curves) starting from the initial long-run equilibrium including the
reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for
Country A’s annual nominal interest rate, i(A), real money balance, M(A)/P(A), and the exchange rate today, E(A/B), to get full marks.
(ii) For the long-run equilibrium, be sure to state the movements (shifts) of all curves (MD and MS
curves in Country A, DR and FR curves) starting from the short-run equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for Country A’s annual nominal interest rate, i(A), real money balance, M(A)/P(A), and the exchange rate, E(A/B), to get full marks.
Q9
Following the permanent fall of the real income, if the central bank of Country A wants to keep the exchange rate at 2.00 all the time, what should be the growth rate (zero decimal places) of the money supply in Country A today?
Use the following information to answer questions 10 and 11.
Suppose the home economy was initially at the long run equilibrium. The consumption in the
country depends on the disposable income, Y-T, C = C(Y-T), and the investment depends on the
interest rate of the country, i, I = I(i). Assume the home country follows a floating exchange rate
system. Now, there is an increase of the expected future spot exchange rate (units of home currency per one unit of foreign currency).
Q10
Use the IS-LM-FX model to explain (in words) the short run effects of the increase in the expected future spot exchange rate. Be sure to explain movements (shifts) of all curves starting from the initial long run equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for the home country's interest rate, income (output) level, and the exchange rate (amount of home currency per one unit of foreign currency) to get full marks.
Q11
Following the increase of the expected future spot exchange rate, the government of the home country changes the government spending to maintain the output at the initial level. Use the IS-LM- FX model to explain (in words) the short run effects of this policy. Be sure to explain movements (shifts) of all curves starting from the short run equilibrium after the increase of the expected future spot exchange rate but before the policy implementation including the reasons for the shifts, and the movements of equilibrium levels relative to the initial long-run equilibrium levels for the interest rate, income (output) level, and the exchange rate (amount of home currency per one unit of foreign currency) to get full marks.
Q12
Suppose the home economy was initially at the long run equilibrium. The consumption in the country depends on the disposable income, Y-T, C = C(Y-T), and the investment depends on the interest rate of the country, i, I = I(i). Assume the home country follows a fixed exchange rate system. Now, the central bank of the home country revaluates its currency, decreases of the current and expected par values of exchange rate, E(H/F), and Ee(H/F). Use the IS-LM-FX model to explain (in words) the short run effects of the revaluation. Be sure to explain movements (shifts) of all curves starting from the initial long run equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for the home country's interest rate, income (output) level, and the exchange rate (amount of home currency per one unit of foreign currency) to get full marks.
ECF2721 SAMPLE EXAM Q&A 2
1. Use the money market with the general monetary model, and foreign exchange (FX) market to answer the following questions. The questions consider the relationship between the U.K. British pound (£) and the Australian dollar ($). In the U.K., the real income (Y£) is 5.0 trillion, the money supply (M£) is £10.0 trillion, the price level (P£) is £4.0, and the nominal interest rate (i£) is 5.0% per annum. In Australia, the real income (Y$) is 2.0 trillion, the money supply (M$) is $8.0 trillion, the price level (P$) is $8.0, and the nominal interest rate (i$) is 5.0% per annum. These two countries have maintained these long-run levels. Thus, the nominal exchange rate (E$/£) has been 2.00. Note that the uncovered interest parity (UIP) holds all the time and the purchasing power parity (PPP) holds only in the long-run. Assume that the new long- run levels are achieved within 1 year from any permanent changes in the economies.
Now, today at time T, the money supply of Australia (M$) rose to $8.24 trillion, by 3.0%, permanently. With the increase of the money supply in Australia, the Australian interest rate falls to 3.0% per annum today. Assume that Y$, Y£, and M£ do not change at all.
(a) Calculate the depreciation rate of the Australian dollar against the U.K. pound today (NOT over one year from today), %ΔE$/£ . Approximation is allowed.
(b) Using the money market for Australia and the FX market diagrams below (replicate them in your answer book), explain (in words) how this change affects the money market for Australia and the FX market.
For the short-run equilibrium, be sure to state the movements (shifts) of all curves (MD and MS curves in Country A, DR and FR curves) starting from the initial long-run equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for Australia’s annual nominal interest rate, i($), real money balance, M($)/P($), and the exchange rate today, E($/£), to get full marks.
For the long-run equilibrium, be sure to state the movements (shifts) of all curves (MD and MS curves in Australia, DR and FR curves) starting from the short-run equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for Australia’s annual nominal interest rate, i($), real money balance, M($)/P($), and the exchange rate, E($/£), to get full marks.
2. Suppose the economy was initially at the long run equilibrium. The consumption in the country depends on the disposable income, Y–T, C = C(Y–T) and the investment depends on the interest rate of the country, i, I = I(i). The applicable IS-LM-FX model is pictured here:
Expected
return
LM1
Assume the home country follows a floating exchange rate system. Now, there is a fall in the foreign interest rate, i*.
(a) Use the IS-LM-FX model to explain the short-run effects of the fall in the foreign interest rate. Be sure to explain movements (shifts) of all curves starting from the initial equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for the home country's interest rate, income (output) level, and the exchange rate (amount of home currency per one unit of foreign currency) to get full marks.
(b) In the situation of (a), use the goods market equilibrium equation and the three elements that determine the trade balance to explain the impact of the policy on
(i) today’s exchange rate, and
(ii) the trade balance of the home country
(increase/no-change/fall) compared to the initial level. (8 marks)
(c) Following the drop of the foreign interest rate, the central bank of the home country changes the money supply to maintain the same level of output as before (Y1). Use the IS-LM-FX model to explain the short-run effects of this policy. Be sure to explain movements (shifts) of all curves starting from the equilibrium in (a) including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for the home country's interest rate, income (output) level, and the exchange rate (amount of home currency per one unit of foreign currency) to get full marks.
ANSWER:
Now with the situation in (a), the central bank has to raise the money supply to maintain the output level at Y1. This shifts the LM curve to the right. Thus, the interest rate falls further which shifts the DR curve further downward. With these changes, the exchange rate becomes higher than (a) but still lower than the initial level of E1.
3. Suppose the economy was initially at the long-run equilibrium. The applicable IS-LM-FX model is pictured here:
Assume the home country follows a fixed exchange rate system. Now, home country devaluates its currency, increases in the current and expected par values of exchange rate, EH/F, and EeH/F.
(a) Assume that the consumption in the country depends on the disposable income, Y–T, C = C(Y–T) and the investment depends on the interest rate, i, I = I(i). Use the IS-LM-FX model to explain the short-run effects of the devaluation. Be sure to explain movements (shifts) of all curves starting from the initial equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for the home country's interest rate, income (output) level, and the exchange rate (amount of home currency per one unit of foreign currency) to get full marks.
(b) Now assume that the consumption in the country depends on the disposable income and the total wealth, Y–T and Wealth, C = C(Y–T, Wealth) and the investment depends on the interest rate and the total wealth of the country, i and Wealth, I = I(i, Wealth). Assume further that the devaluation of the country’s currency increases its total wealth significantly due to the valuation effect on the external wealth. Use the IS-LM-FX model to explain the short-run effects of the devaluation together with the valuation effects on the total wealth. Be sure to explain movements (shifts) of all curves starting from the initial equilibrium including the reasons for the shifts, the movements of equilibrium levels (relative to the case in (a)) for the home country's interest rate, income (output) level, and the exchange rate (amount of home currency per one unit of foreign currency) to get full marks.