Econ 345 â International Finance
MGEC61 Sample Final Questions These are some of the past Final exam questions. These questions are compiled from different exams (the total marks do not add up to 100) and are for your reference only. You should also practice the review questions and assignments. Question 1 (15 points) Under political pressure the government of Home has to loosen its immigration policy by increasing the number of immigrants the country received each year. As a result, the labour force in Home increases. According to the generalized model of long-run exchange rate, what happen to the domestic price level, the DC/FC real exchange rate, and the DC/FC nominal exchange rate? Explain. Question 2 (10 points) The country in question adopts a flexible exchange rate. If a government initially has a balanced budget but then decides to cut taxes temporarily, it is running a deficit that it must somehow finance. Suppose people think the government will finance its deficit by printing the extra money it now needs to cover its expenditures. Would you still expect the tax cut to cause a currency appreciation in the short run? Explain and use the DD-AA model to support your answer. Question 3 (10 points) Suppose there is a permanent change in the preference of domestic residents such that they decide to consume less goods and services for all levels of income. Knowing that you are an expert in international finance, the government hires you to study about which exchange rate regime the country should adopt to minimize fluctuations in output. What kind of advice would you give to the government? Explain in words and in a DD-AA diagram. Question 4 (10 points) Consider an economy that adopts a floating exchange rate, it is currently operating above its long-run capacity and is running a current account deficit. The country wants to get back to its long-run production capacity and to correct its current account, what kind of policy should the policy makers pursue in the short run? Use DD-AA model to support your answer. Question 5 (15 points) Consider an economy, which has a fixed exchange rate regime, is currently producing above its full-employment level of output. Believing the economy overheats, the central bank decides to use contractionary monetary policy to cool down the economy. a) Use the DD-AA model to demonstrate the effect of this change in policy on the country’s level of output in the short run. Can the central bank achieve its goal by using contractionary monetary policy in the short run? (9 points) b) What would happen to this economy in the long run? Explain in the context of the DD-AA model (Use the diagram you drew in part (a) to support your answer, no credit will be given if you draw a new one). (6 points)
MGEC61 Sample Final Questions
Iris Au
1
Question 6 (20 points) “An economy that has a flexible exchange rate system will experience twin deficits when the government lowers taxes.” True/False/Uncertain, explain with the aid of ONE DD-AA diagram (Assume the economy is currently at its long-run equilibrium and all accounts are in balance. Also, compare the new equilibrium to the initial equilibrium). Question 7 (15 points) Suppose that people at Home finally realize that they must save a larger portion of their income in order to retire and that they simultaneously begin to use new technology, which allows them to reduce their holdings of real cash balances as a proportion of their income. In addition, Home let the market forces of demand and supply to determine the value of its currency against foreign currency. In the context of the DD-AA model, what happens to output and exchange rate in the short run? Explain in words and in ONE diagram, and assume the changes are transitory. Question 8 (10 points) “Fixed exchange rate, rather than flexible exchange rate, will lead to a smaller change in output in the short run when the economy experiences a series of credit card fraud.” True/False/Uncertain, explains in the context of the DD-AA model, and supports your argument by ONE appropriate diagram (assume the change is temporary). Question 9 (15 points) Consider a country that operates under a managed float exchange rate system and investors perceive domestic assets and foreign assets as imperfect substitutes. Suppose the domestic central bank undertakes a sterilized foreign exchange intervention by selling foreign currency (assume it is a temporary change). a) What impact will this policy have on the spot exchange rate in the short run, assuming real output and price level remains unchanged? Use word and a diagram that displays the domestic money market and the foreign exchange market to support your argument and assume the change in temporary. b) Now, let’s take the changes in output into consideration. Use the DD-AA model to show and explain the effects of this sterilized foreign exchange intervention on the short-run level of output and exchange rate. Question 10 (10 points) In the context of the two-country model, could a monetary contraction at home be a “beggar-thyneighbor” policy? Explain.
MGEC61 Sample Final Questions
Iris Au
2
Question 11 (15 points) There was a vigorous debate among economists in Canada on whether Canada should form a currency union with the U.S. Now, suppose that Canadian economists agree that the Canadian dollar (C$) should be fixed to the U.S. dollar (US$). Shortly after fixing the C$ to the US$, there is a temporary increase in the European Union (EU) demand for the U.S. exports but not for the Canadian exports. a) How are the Canadian current account and output affected in the short run and why? Use words and diagrams to support your answer. (Hint: Your diagrams should consist of 2 markets, one for the Canadian market and the other for the U.S. market) (12 points) b) What kind of macroeconomic policy could the Canadian government undertake to offset the impact on Canadian output level? (Use words to explain your answer only) (3 points) Question 12 (10 points) There is a debate within Europe about widening the membership of the European Union (EU) and subsequently the euro zone. Suppose the two countries of Alpha and Beta each wanted to become members of the euro area. Explain how each of the following factors affects the comparative net benefits to Alpha and Beta of replacing their own domestic currency with the euro. a) The industrial structure of Beta is much similar to that of Germany and France than is the industrial structure of Alpha. (5 points) b) Beta produces a set of goods very different from those produced in the EU while Alpha produces a more similar set of goods; therefore, there is a greater potential for trade between the euro area countries and Beta than between the euro area countries and Alpha. (5 points) Question 13 (15 points) Suppose the world consists of 2 large countries, Sharkcity (SC) and Robotcity (RC). The central bank of Sharkcity has the options to keep its monetary policy from changing (CMP) or to pursue a restrictive monetary policy (RMP). The government of Robotcity can choose between holding its fiscal policy at its current level (CFP) and expansionary fiscal policy (EFP). The payoffs of the interactions of both countries’ stabilization policies are summarized as follow: RC CFP EFP 0, 0 6, 3 SC CMP 4, 2 3, 1 RMP (SC’s payoff, RC’s payoff) a) Write down the strategies for both countries? (4 points) b) If the central bank of Sharkcity chooses its monetary policy and the government of Robotcity chooses its fiscal policy simultaneously, find the Nash equilibrium(s). Does the problem of coordination failure exist? Explain. (5 points) c) If the government of Robotcity and the central bank of Sharkcity can meet and discuss the choices of their respective stabilization policies before implementing them, find the Nash equilibrium. Does the problem of coordination failure exist? Explain. (6 points)
MGEC61 Sample Final Questions
Iris Au
3
Question 14 (20 points) Consider an economy that has a flexible exchange rate. The economy can be represented by the following equations: DD equation: Y = 1500 – 10P + 10E MS e AA equation: Y 500 2 100E 100E P Long run output level: YFE = 2000 Money Supply: MS = 15000 Note: Exchange rate is expressed as EDC/FC. Keep your answer to 2 decimal points if necessary. a) Solve for the long-run values of output, price level, and exchange rate for this economy, if the expected exchange rate, Ee, is 70. (5 points) b) Owing to the recent oil price increases, the government decides to provide a tax cut to its residents. The new DD equation is Y = 1600 – 10P + 10E Besides, the market believes this tax cut will be a permanent one; therefore, they expect an appreciation of DC to 60. What are the levels of output, price, and exchange rate in the short run? (5 points) c) Redo part (b) if agents expect the tax cut is a temporary one. (5 points) d) Use words and a DD-AA diagram to explain your answers in parts (b) and (c). (5 points) Question 15 (20 points) The economy in question can be described by the DD-AA model: DD equation: Y = 7000 – 200P + 100E, where E = EDC/FC MS e AA equation: Y 2500 10 500E 500E P 1/3 2/3 Long-run output level: YFE = K L This economy has 15625 units of capital and 8000 workers, and the initial level of money supply is 7500. Note: Keep your answer to 2 decimal points if necessary. a) Find the long-run values of output, exchange rate, price level, and real money balance if the expected exchange rate is 50. (5 points) b) The economy is initially at its long-run equilibrium as described in part (a) and has a flexible exchange rate. Now, a wave of pessimism has swept the country, and autonomous consumption falls permanently. New DD equation becomes: Y = 2000 – 200P + 100E Knowing that this is a permanent change, the new expected exchange rate is 100. Find the short-run equilibrium levels of output, exchange rate, and real money balance. (5 points) c) Redo part (b) if the country has a fixed exchange rate and (nominal) money supply is used to maintain the exchange rate. (5 points) d) Explain in your answers in parts (b) and (c) with the support of ONE DD-AA diagram. (5 points)
MGEC61 Sample Final Questions
Iris Au
4
Question 16 (20 points) Suppose an open economy that can be represented by the following equations: DD equation: Y = 2000 – 200P + 200E, where E = EDC/FC MS e AA equation: Y 1000 10 500E 500E P Long-run output level: YFE = L1/2K1/2 The stock of capital and the size of labour force in this economy are 2500 and 10000 respectively. This economy fixes its currency at 50 DC per FC. Besides, the central bank adjusts real money supply (MS/P) to keep the exchange rate fixed. a) What are the long-run equilibrium values of output and real money supply? (5 points) b) The economy is initially at its long-run equilibrium and the price level is 35. Now, the economy experiences a permanent fall in consumption and the new DD equation is: Y = 1500 – 200P + 200E What are the short-run equilibrium levels of output and real money supply? (5 points) c) Redo part (b) if the economy experiences a permanent fall in money demand (no change in consumption), and the new AA equation is: MS e Y 1600 10 500E 500E . (5 points) P d) Explain in your answers in parts (b) and (c) with the support of ONE DD-AA diagram. (5 points) Question 17 (15 points) Consider two countries: ABC and XYZ. Both countries are revising their stabilization policies, and their interactions are summarized in the following payoff matrix: XYZ R R 3, 3 1, 2 G 1, 0 6, 2 G Payoff = (ABC, XYZ) Note: You must follow the above notations. No credit will be given if you change the notations. ABC
a) Write down the strategies for both countries. (4 points) b) If both central banks make their choices simultaneously, find all possible Nash equilibrium/equilibria. Does the problem of coordination failure exist? Explain. (5 points) c) Find the Nash equilibrium if ABC makes its choice first and then XYZ follows. Does ABC’s action serve as an “engine of growth”? Explain. (6 points)
MGEC61 Sample Final Questions
Iris Au
5
Question 18 (15 points) The Dong (D), Vietnam’s currency, is fixed to the U.S. dollar (US$). Suppose the recent financial crisis in the U.S. has temporarily changed the consumption behaviour of the American households such that they now buy more domestically made products and less foreign goods (including Vietnam’s goods); but the aggregate level of expenditure (the total amount spent on domestic and foreign goods) by households remains unchanged. A study shows that Vietnam and the U.S. have different economic structures. Explain what happens to the short-run equilibrium level of output in both the U.S. and Vietnam, and support your answer by TWO appropriate DD-AA diagrams. In this question, let the euro (€) be the third currency. In your diagram and written explanation, use the subscripts “V” and “US” to denote all the variables and terms used for Vietnam and the U.S. respectively. You must follow these notations; otherwise, you will receive a grade of ZERO for the whole question. Question 19 (20 points) A small open economy can be described by the following equations: DD equation: Y = 25500 – 25P + 750E, where E = EDC/FC M S e AA equation: Y = 17550 + 5 + 500E – 500E P Long-run output level: YFE = 4K1/3L2/3 Note: Be sure to show your work and keep your answer to 4 decimal points if necessary. a) This economy has 1000 units of capital and 15625 workers, and the level of (nominal) money supply is 74500. Compute the long-run equilibrium values of DC/FC exchange rate and real money balance if the market believes the expected value of DC (Ee) is at par with FC. (6 points) b) The economy has a flexible exchange rate system and is initially in its long-run equilibrium as shown in part (a). Now, there is a permanent change in the demand for domestic goods such that the DD curve becomes: Y = 25650 – 25P + 750E The market revises its expectation on exchange rate (Ee) and expects DC to appreciate by 20%. What are the equilibrium values of output, DC/FC exchange rate, and real money balance in the short run? In the long run? (8 points) c) If the (domestic) central bank finds the change in short-run DC/FC exchange rate in part (b) undesirable and wants to keep it at the initial long-run value, what should it do? Find the level of money supply that could achieve the goal of the central bank in the short run (assume the change in money supply is temporary). (6 points)
MGEC61 Sample Final Questions
Iris Au
6
Question 20 (20 points) “A financial crisis hits the country; it has changed the demand for liquidity permanently such that households have lost their confidence in financial assets such as stocks and they demand to hold more risk-free assets. The DD-AA model predicts this change in demand for liquidity will have no effects on nominal interest rate and current account.” True/False/Uncertain, explain with the aid of ONE DD-AA diagram (only the first diagram will be graded). Note: Compare your answer to the initial long-run equilibrium. Question 21 (20 points) This question is about a small open economy that has a fixed exchange rate. Suppose a wave of pessimism sweeps the country such that both households and firms decide to spend less. To make things worse, the market believes this wave of pessimism has a permanent effect on the economy. a) What happens to output in the short run? Explain and support your answer by one DD-AA diagram (only the first diagram will be graded). (6 points) b) Instead of having fixed prices in the short run, prices are flexible in the short run. What happens to output in the short run? Explain and support your answer by the DD-AA diagram you drew in part (a). No credit will be given if you drew a new diagram. (8 points) c) Based on your answers in previous parts, would the inability to use monetary policy to smooth out business cycles be a problem? Yes/No, explain. (6 points)
MGEC61 Sample Final Questions
Iris Au
7
MGEC61 Sample Final Questions
Iris Au
1
Question 6 (20 points) “An economy that has a flexible exchange rate system will experience twin deficits when the government lowers taxes.” True/False/Uncertain, explain with the aid of ONE DD-AA diagram (Assume the economy is currently at its long-run equilibrium and all accounts are in balance. Also, compare the new equilibrium to the initial equilibrium). Question 7 (15 points) Suppose that people at Home finally realize that they must save a larger portion of their income in order to retire and that they simultaneously begin to use new technology, which allows them to reduce their holdings of real cash balances as a proportion of their income. In addition, Home let the market forces of demand and supply to determine the value of its currency against foreign currency. In the context of the DD-AA model, what happens to output and exchange rate in the short run? Explain in words and in ONE diagram, and assume the changes are transitory. Question 8 (10 points) “Fixed exchange rate, rather than flexible exchange rate, will lead to a smaller change in output in the short run when the economy experiences a series of credit card fraud.” True/False/Uncertain, explains in the context of the DD-AA model, and supports your argument by ONE appropriate diagram (assume the change is temporary). Question 9 (15 points) Consider a country that operates under a managed float exchange rate system and investors perceive domestic assets and foreign assets as imperfect substitutes. Suppose the domestic central bank undertakes a sterilized foreign exchange intervention by selling foreign currency (assume it is a temporary change). a) What impact will this policy have on the spot exchange rate in the short run, assuming real output and price level remains unchanged? Use word and a diagram that displays the domestic money market and the foreign exchange market to support your argument and assume the change in temporary. b) Now, let’s take the changes in output into consideration. Use the DD-AA model to show and explain the effects of this sterilized foreign exchange intervention on the short-run level of output and exchange rate. Question 10 (10 points) In the context of the two-country model, could a monetary contraction at home be a “beggar-thyneighbor” policy? Explain.
MGEC61 Sample Final Questions
Iris Au
2
Question 11 (15 points) There was a vigorous debate among economists in Canada on whether Canada should form a currency union with the U.S. Now, suppose that Canadian economists agree that the Canadian dollar (C$) should be fixed to the U.S. dollar (US$). Shortly after fixing the C$ to the US$, there is a temporary increase in the European Union (EU) demand for the U.S. exports but not for the Canadian exports. a) How are the Canadian current account and output affected in the short run and why? Use words and diagrams to support your answer. (Hint: Your diagrams should consist of 2 markets, one for the Canadian market and the other for the U.S. market) (12 points) b) What kind of macroeconomic policy could the Canadian government undertake to offset the impact on Canadian output level? (Use words to explain your answer only) (3 points) Question 12 (10 points) There is a debate within Europe about widening the membership of the European Union (EU) and subsequently the euro zone. Suppose the two countries of Alpha and Beta each wanted to become members of the euro area. Explain how each of the following factors affects the comparative net benefits to Alpha and Beta of replacing their own domestic currency with the euro. a) The industrial structure of Beta is much similar to that of Germany and France than is the industrial structure of Alpha. (5 points) b) Beta produces a set of goods very different from those produced in the EU while Alpha produces a more similar set of goods; therefore, there is a greater potential for trade between the euro area countries and Beta than between the euro area countries and Alpha. (5 points) Question 13 (15 points) Suppose the world consists of 2 large countries, Sharkcity (SC) and Robotcity (RC). The central bank of Sharkcity has the options to keep its monetary policy from changing (CMP) or to pursue a restrictive monetary policy (RMP). The government of Robotcity can choose between holding its fiscal policy at its current level (CFP) and expansionary fiscal policy (EFP). The payoffs of the interactions of both countries’ stabilization policies are summarized as follow: RC CFP EFP 0, 0 6, 3 SC CMP 4, 2 3, 1 RMP (SC’s payoff, RC’s payoff) a) Write down the strategies for both countries? (4 points) b) If the central bank of Sharkcity chooses its monetary policy and the government of Robotcity chooses its fiscal policy simultaneously, find the Nash equilibrium(s). Does the problem of coordination failure exist? Explain. (5 points) c) If the government of Robotcity and the central bank of Sharkcity can meet and discuss the choices of their respective stabilization policies before implementing them, find the Nash equilibrium. Does the problem of coordination failure exist? Explain. (6 points)
MGEC61 Sample Final Questions
Iris Au
3
Question 14 (20 points) Consider an economy that has a flexible exchange rate. The economy can be represented by the following equations: DD equation: Y = 1500 – 10P + 10E MS e AA equation: Y 500 2 100E 100E P Long run output level: YFE = 2000 Money Supply: MS = 15000 Note: Exchange rate is expressed as EDC/FC. Keep your answer to 2 decimal points if necessary. a) Solve for the long-run values of output, price level, and exchange rate for this economy, if the expected exchange rate, Ee, is 70. (5 points) b) Owing to the recent oil price increases, the government decides to provide a tax cut to its residents. The new DD equation is Y = 1600 – 10P + 10E Besides, the market believes this tax cut will be a permanent one; therefore, they expect an appreciation of DC to 60. What are the levels of output, price, and exchange rate in the short run? (5 points) c) Redo part (b) if agents expect the tax cut is a temporary one. (5 points) d) Use words and a DD-AA diagram to explain your answers in parts (b) and (c). (5 points) Question 15 (20 points) The economy in question can be described by the DD-AA model: DD equation: Y = 7000 – 200P + 100E, where E = EDC/FC MS e AA equation: Y 2500 10 500E 500E P 1/3 2/3 Long-run output level: YFE = K L This economy has 15625 units of capital and 8000 workers, and the initial level of money supply is 7500. Note: Keep your answer to 2 decimal points if necessary. a) Find the long-run values of output, exchange rate, price level, and real money balance if the expected exchange rate is 50. (5 points) b) The economy is initially at its long-run equilibrium as described in part (a) and has a flexible exchange rate. Now, a wave of pessimism has swept the country, and autonomous consumption falls permanently. New DD equation becomes: Y = 2000 – 200P + 100E Knowing that this is a permanent change, the new expected exchange rate is 100. Find the short-run equilibrium levels of output, exchange rate, and real money balance. (5 points) c) Redo part (b) if the country has a fixed exchange rate and (nominal) money supply is used to maintain the exchange rate. (5 points) d) Explain in your answers in parts (b) and (c) with the support of ONE DD-AA diagram. (5 points)
MGEC61 Sample Final Questions
Iris Au
4
Question 16 (20 points) Suppose an open economy that can be represented by the following equations: DD equation: Y = 2000 – 200P + 200E, where E = EDC/FC MS e AA equation: Y 1000 10 500E 500E P Long-run output level: YFE = L1/2K1/2 The stock of capital and the size of labour force in this economy are 2500 and 10000 respectively. This economy fixes its currency at 50 DC per FC. Besides, the central bank adjusts real money supply (MS/P) to keep the exchange rate fixed. a) What are the long-run equilibrium values of output and real money supply? (5 points) b) The economy is initially at its long-run equilibrium and the price level is 35. Now, the economy experiences a permanent fall in consumption and the new DD equation is: Y = 1500 – 200P + 200E What are the short-run equilibrium levels of output and real money supply? (5 points) c) Redo part (b) if the economy experiences a permanent fall in money demand (no change in consumption), and the new AA equation is: MS e Y 1600 10 500E 500E . (5 points) P d) Explain in your answers in parts (b) and (c) with the support of ONE DD-AA diagram. (5 points) Question 17 (15 points) Consider two countries: ABC and XYZ. Both countries are revising their stabilization policies, and their interactions are summarized in the following payoff matrix: XYZ R R 3, 3 1, 2 G 1, 0 6, 2 G Payoff = (ABC, XYZ) Note: You must follow the above notations. No credit will be given if you change the notations. ABC
a) Write down the strategies for both countries. (4 points) b) If both central banks make their choices simultaneously, find all possible Nash equilibrium/equilibria. Does the problem of coordination failure exist? Explain. (5 points) c) Find the Nash equilibrium if ABC makes its choice first and then XYZ follows. Does ABC’s action serve as an “engine of growth”? Explain. (6 points)
MGEC61 Sample Final Questions
Iris Au
5
Question 18 (15 points) The Dong (D), Vietnam’s currency, is fixed to the U.S. dollar (US$). Suppose the recent financial crisis in the U.S. has temporarily changed the consumption behaviour of the American households such that they now buy more domestically made products and less foreign goods (including Vietnam’s goods); but the aggregate level of expenditure (the total amount spent on domestic and foreign goods) by households remains unchanged. A study shows that Vietnam and the U.S. have different economic structures. Explain what happens to the short-run equilibrium level of output in both the U.S. and Vietnam, and support your answer by TWO appropriate DD-AA diagrams. In this question, let the euro (€) be the third currency. In your diagram and written explanation, use the subscripts “V” and “US” to denote all the variables and terms used for Vietnam and the U.S. respectively. You must follow these notations; otherwise, you will receive a grade of ZERO for the whole question. Question 19 (20 points) A small open economy can be described by the following equations: DD equation: Y = 25500 – 25P + 750E, where E = EDC/FC M S e AA equation: Y = 17550 + 5 + 500E – 500E P Long-run output level: YFE = 4K1/3L2/3 Note: Be sure to show your work and keep your answer to 4 decimal points if necessary. a) This economy has 1000 units of capital and 15625 workers, and the level of (nominal) money supply is 74500. Compute the long-run equilibrium values of DC/FC exchange rate and real money balance if the market believes the expected value of DC (Ee) is at par with FC. (6 points) b) The economy has a flexible exchange rate system and is initially in its long-run equilibrium as shown in part (a). Now, there is a permanent change in the demand for domestic goods such that the DD curve becomes: Y = 25650 – 25P + 750E The market revises its expectation on exchange rate (Ee) and expects DC to appreciate by 20%. What are the equilibrium values of output, DC/FC exchange rate, and real money balance in the short run? In the long run? (8 points) c) If the (domestic) central bank finds the change in short-run DC/FC exchange rate in part (b) undesirable and wants to keep it at the initial long-run value, what should it do? Find the level of money supply that could achieve the goal of the central bank in the short run (assume the change in money supply is temporary). (6 points)
MGEC61 Sample Final Questions
Iris Au
6
Question 20 (20 points) “A financial crisis hits the country; it has changed the demand for liquidity permanently such that households have lost their confidence in financial assets such as stocks and they demand to hold more risk-free assets. The DD-AA model predicts this change in demand for liquidity will have no effects on nominal interest rate and current account.” True/False/Uncertain, explain with the aid of ONE DD-AA diagram (only the first diagram will be graded). Note: Compare your answer to the initial long-run equilibrium. Question 21 (20 points) This question is about a small open economy that has a fixed exchange rate. Suppose a wave of pessimism sweeps the country such that both households and firms decide to spend less. To make things worse, the market believes this wave of pessimism has a permanent effect on the economy. a) What happens to output in the short run? Explain and support your answer by one DD-AA diagram (only the first diagram will be graded). (6 points) b) Instead of having fixed prices in the short run, prices are flexible in the short run. What happens to output in the short run? Explain and support your answer by the DD-AA diagram you drew in part (a). No credit will be given if you drew a new diagram. (8 points) c) Based on your answers in previous parts, would the inability to use monetary policy to smooth out business cycles be a problem? Yes/No, explain. (6 points)
MGEC61 Sample Final Questions
Iris Au
7
