International Macroeconomic Policy SEESGS79
International Macroeconomic Policy
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International Macroeconomic Policy
SEESGS79
Time: Two hours
Calculators are not permitted
Instructions:
Answer any THREE questions in section A (do not answer more than THREE
questions).
Answer ONE of the questions in section B.
Answer ONE of the questions in section C.
Section A is worth 36% of the final mark, section B is worth 32% of the mark, and
section C is worth 32% of the mark.
Section A (36 points): Answer any THREE of the following questions (do not answer
more than THREE questions):
State whether the following statements are true, false or uncertain and provide a short
explanation carefully justifying your answer. Marks are only awarded for the
justification (argument, algebra, graphs etc.) that you provide.
1. An increase in the probability that a central bank will raise its interest rate next year
appreciates the exchange rate today. (12 points)
2. Monetary policy is not effective for countries that choose a floating currency regime.
(12 points)
3. In the first-generation model of speculative attacks, accumulating central bank
reserves is a way to protect a country against speculative attacks. (12 points)
4. According to the second-generation model of speculative attacks, it is possible to
deter speculative attacks by making the fixed exchange rate regime a legal,
Constitutional, feature. (12 points)
5. The only way to ensure inflation is low in a country is to appoint a central banker who
is willing to trade-off high unemployment against a small reduction in inflation. (12
points)
CONTINUED
Section B (32 points): Answer the following questions:
1. Real exchange rate model. Assume the Home country and the USA are the only two
countries in the world. The Home country’s currency is the Peso. The Peso is pegged
to the US dollar with exchange rate 1 US dollar = E Pesos (an increase in E is a
depreciation of the peso). Also assume firms in the non-tradable sector in the Home
country require labour LN to produce non-tradable goods sold at price PN (in pesos).
Firms in the tradable sector require labour LT to produce tradable goods sold at price
PT (in pesos). In addition, the Home country produces a large quantity of oil O, with
price, in USA dollar, pO. Oil production does not require any labour.
a. Define the real exchange R. When does the real exchange rate appreciate? (3
points).
b. In the Home country, workers can move freely, working either in firms in the
non-tradable sector or in firms in the tradable sector. What does that imply for
the wage in the non-tradable sector WN? (4 points)
c. Without proving these relationships, explain how and why the supply of non-
tradables depends on the real exchange rate and how and why the supply of
tradables depends on the real exchange rate. (5 points)
d. Without proving these relationships, write how and explain why the demands
for tradables and non-tradables depend on the real exchange rate and on the
economy’s national income Y. (2 points)
e. In a chart with Y on the horizontal axis and R on the vertical axis, draw, and
explain how you draw them, the locus representing the internal balance and
the locus representing the external balance. (8 points)
f. Suppose the price of oil collapses. What does this fall in the price of oil imply
for the current account and for the external balance schedule (and why)? Using
the chart constructed for question (c), what does this oil price collapse imply
for the real exchange rate and income. Which policies should a government
adopt to limit the effect of ongoing and future oil price shocks on the economy
(10 points)
Section C (32 points): Answer the following two questions:
1. Mervyn King, former governor of the Bank of England, once famously noted:
“Central banks are often accused of being obsessed with inflation. This is untrue. If
they are obsessed with anything, it is with fiscal policy.” Explain why this may be the
case. (32 points)
2. “There was a real fear that a euro-zone bank might fail, that we'd have a sovereign
debt problem in one of the larger European economies. That's dissipated, thanks
largely to the action of the European Central Bank.” (G. Osborne). Explain which
ECB policies were taken and how they relate to the theories of speculative attacks.