ECM158 International Macroeconomics
International Macroeconomics
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ECM158 International Macroeconomics Assignment
This coursework is worth 70 percent of your overall mark. It consists of five equally
weighted questions, of which you must answer three and only three. Each question is
worth 100 marks, with marks of sub-parts as indicated in brackets.
Answers must be submitted as either a Word or a PDF file, with all textual material
typed in font size 11 or 12. Mathematical equations and diagrams may be hand-
written and inserted as scans but the scans must be clear and the handwriting
legible. All mathematical and diagrammatic material should be relevant to and fully
explained within the accompanying text.
Answer THREE questions
1. (a) Discuss the assumptions of the Swan diagram analysis. (40 marks)
(b) Present graphically and discuss the Swan diagram. (60 marks)
2. Consider a small open economy in which there are no restrictions on trade or
capital flows but domestic and foreign assets are imperfect substitutes. Suppose the
exchange rate is not allowed to float and the economy is initially in IS-LM-BP
equilibrium. The Central Bank devalues the currency by surprise. Explain in words
and with the help of diagrams how the economy will react
(a) immediately (40 marks)
(b) over time when it reaches a new equilibrium (40 marks)
(c) why is it important that the devaluation is assumed to be by surprise? (20 marks)
3. Explain in words (50 marks) and with the help of diagrams (50 marks) the
relationship between Spot and Forward Markets.
4. Consider the assumptions of the first generation of exchange rate crisis models,
for which the relevant equations describing the economy under the fixed regime
are given by
where M,D,F represent money supply, domestic credit and foreign reserves, i is
the interest rate fixed at the foreign rate i*, P is the domestic price and is the
fixed exchange rate.
0ba,SPbi-aM/PFDM ==+=
S
When exchange rates are floating, and in the absence of foreign reserves, the
equations are given by
where S is the exchange rate and E[.] represents the expectations operator, with
expectations assumed to be rational.
(a) Show that ̅ =
0+0
−∗
where D0 , F0 are the initial values of D
and F at the start of this increase in domestic credit. (5 marks)
(b) Analyse the timing of a speculative attack in this model when domestic
credit is growing at a velocity , i.e. D=D0+t, and verify that under
floating, the exchange rate is given by
=
0+
−∗
+
(−∗)2
(55 marks)
(c) By equating the above equation to ̅, show that the time of the attack on
the currency is given by =
0
−
−∗
(20 marks)
(d) How is the time of the attack affected by changes in F0 and ? (20 marks)
5. (a) Describe a simplified version of the balance sheet of the banking system,
to include gold, foreign reserves, currency, deposits and loans for both the
central bank and the commercial banks. Describe also the consolidated
banking sector, and explain the relationship to money supply. (25 marks)
(b) Explain the key components of the Monetary Approach to the Balance of
Payments (MABP), paying particular attention to the current account,
changes in money supply, money demand and the aggregate demand
schedule. (25 marks)
(c) Analyse the effects of a monetary expansion under a fixed exchange rate
regime, according to the MABP. (25 marks)
(d) What is the key implication of your analysis of (c) that enables a statistical
test of the MABP? Outline the empirical results. (25 marks)