SESS0068 - International Macroeconomics

Section A

Choose the most appropriate answer(s) to each question. No explanation is required. There may be more than one answers for each question. You get no point when your answer is incomplete or wrong. (2 points for each question, 28 points in total)

1. According to absolute purchasing power parity (PPP)

A. countries with lower domestic inflation should see a depreciation of their currency

B. countries with higher domestic inflation should see a depreciation of their currency

C. the rate of change in the nominal exchange rate equals the inflation differential between two countries

D. a country’s prices are set in a foreign currency

2. Uncovered interest rate parity implies that:

A. The interest rates between two countries start in equilibrium, any change in the differential rate of inflation between the two countries tends to be offset over the long-term by an equal but opposite change in the spot exchange rate

B. Interest rates should change by an equal amount but in the opposite direction to the difference in inflation rates between two countries

C. Nominal interest rates in each country are equal to the required real rate plus compensation for expected inflation

D. The difference in interest rates in different currencies for securities of similar risk and maturity should be consistent with the expected changes in future exchange rate for the foreign currency

3. In 2006-2007, the domestic inflation rate in China has been around 6-8%. Which of the following statement is correct?

A. Inflation leads to loss of competitiveness for the Chinese export sector therefore this is bad for the Chinese economy.

B. If the Chinese currency (RMB) was allowed to revalue, the domestic inflation may have been reduced.

C. The US experienced similar level of inflation that year and this is a world problem

D. The average inflation rate in an emerging economy is often higher than in the developed world as what “Balassa-Samuelson model” suggests

4. In an open economy, a shortfall in domestic savings to finance domestic investment will lead to

A. a current account deficit and (net) capital inflows

B. a current account deficit and (net) capital outflows

C. a current account surplus and (net) capital inflows

D. a current account surplus and (net) capital outflows

5. The J-curve illustrates which of the following?

A. the short-term effects of depreciation on the trade balance

B. the immediate increase in current account caused by a currency depreciation

C. the effects of depreciation on the home country's output level

D. the gradual adjustment of home prices to a currency depreciation

6. Country A has a current account deficit of $5 billion, and a non-reserve financial account surplus of $5 billion dollars. Which of the following statements is correct?

A. Country A’s net foreign assets decline by 5 billion dollars

B. Country A may have a floating exchange rate

C. Country A’s net foreign assets decline by 5 billion dollars

D. Country A’s net foreign assets decline by 10 billion dollars

7. Which of the following exchange rate systems does/do not require foreign exchange reserves for intervention?

A. floating exchange rates

B. pegged exchange rates

C. managed floating exchange rates

D. dual exchange rates

8. Suppose the central bank of Mexico is pegging its currency, the peso, to the U.S. dollar at a rate of 0.1$ per peso. If on a particular day the demand for pesos exceeds the supply by 1.3 billion pesos, the central bank will

A. Devalue the peso.

B. Use its reserves of U.S. dollars to buy 1.3 billion pesos.

C. Buy 1.3 billion pesos on the open market and sell them to those whose demands are not being met by private supply

D. Prohibit individuals from selling pesos for more than the official rate.

E. Add to its dollar reserves by $130,000,000.

9. The pound-dollar exchange rate is 0.6 pounds to the dollar. The yen-dollar exchange rate is 180 yen to the dollar. The yen-pound exchange rate is 120 yen to the pound. Starting with 10 pound, you can make arbitrage profits of

A. zero

B. 10 pound

C. 15 pounds

D. 20 pounds

10. Due to Japan's high saving rate, suppose that the Japanese invest abroad. This investment may result in a/an ______ of the Japanese yen and therefore a _______ for Japan.

A. appreciation; trade surplus

B. appreciation; trade deficit

C. depreciation; trade surplus

D. depreciation; trade deficit

Section B

Answer ALL the questions. Marks are only awarded for a brief justification (argument, algebra, graphs, etc.) that you provide. Points for each question are indicated below.

Question 1.

A Big Mac costs US$ 6.66 in the United States and Norweigian Krone (NKr) 60 in Norway. The actual nominal exchange rate 8.04 Nkr per US$. If PPP holds in the long-run, using the big Mac index information, please indicate how much is Norweigian Krone overvalued or undervalued? (5 points)

Question 2.

Since 1992, the UK has a flexible exchange rate and perfect capital mobility. On the day of the Brexit referendum, investors in the foreign exchange market started expecting a gloomy future of the British economy and hence large depreciation of the British Pound in the future. Characterise verbally and graphically the effects on interest rate and exchange rate. (5 points)

Question 3.

Assume Russia and the U.S. are the only two countries in the world. Let Russia be the home country and the US the foreign country and RUBLE/USD is the exchange rate. Suppose the law of one price holds for the traded goods and the share of non-traded goods in price indices is n=0.7 in both countries. Answer the following questions. School of Slavonic and East European Studies LATE SUMMER ASSESSMENT 2020/21 Page 7 of 9 SESS0068

a). Suppose there is 4 % growth per year in tradable sector and 1% per year in non-tradable sector in Russia. In the US productivity growth at 2.5% in both sectors. What is the change in real exchange rate and what happens to Russian Ruble? (5 points)

b). Russia is currently using a floating exchange rate regime. Suppose that there is an inflation rate of 2% per year in Russia and there is a deflation rate of 1% per year in the US. What will happen to the nominal exchange rate of ROUBLE every year if relative PPP holds? (5 points) (Hint: You need to use your answer in section a)