ECON3104/5304: International Macroeconomics
International Macroeconomics
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ECON3104/5304: International Macroeconomics
Sample Questions for Exams
Exercise: Consider an investor with 100,000 euros who must decide whether to invest her funds in
euro deposits or pound deposits. The one-year pound deposit is 4% (or 0.04), whereas the one-year
euro deposit is 10% (or 0.10). The exchange rate today is 1.05 euros/pound. What forward rate
(euros/pound) would make the investor indifferent between investing in euros or pounds? Explain.
Exercise: Consider an investor who must decide whether to invest his funds in dollar deposits
or euro deposits. Suppose this investor does not have access to forward contracts and can only use
spot exchange rates. The dollar one-year interest rate is 8% and the euro one-year interest rate is
3%. The current exchange rate is 1 dollar/euro, and the investor expects the dollar to depreciate
at a rate of 4% over the course of the year. What type of deposit should the investor choose if he
wants to make a profit? Explain.
Exercise: Consider the following information: in Argentina, a Big Mac costs 28 pesos, whereas
in the US a Big Mac costs $4.79. The exchange rate in Argentina is 8.61 pesos/dollar. Is the Ar-
gentinean pesos overvalued or undervalued with respect to the US dollar? By how much? Explain
why the peso is overvalued/undervalued. What exchange rate (pesos/dollar) would be required so
that the Purchasing Power Parity theory holds between Argentina and the US? Explain.
Exercise Suppose that the inflation rate in the US is 2% and that the inflation rate in Switzerland
is 4%. What variation in the dollar/Swiss franc exchange rate is necessary so that the purchasing
power parity holds? Does this variation in the exchange rate imply an appreciation or a depreciation
of the US dollar? Explain.
Exercise You are the central banker for a country that is considering the adoption of a new
nominal anchor. When you take the position as chair-person, the inflation rate is 4% and your
position as the central bank chairperson requires that you achieve a 2.5% inflation target within
the next year. The economy’s growth in real output is currently 3%. The world real interest rate
is currently 1.5%. The currency used in your country is the lira. Assume prices are flexible.
(a) Why is having a nominal anchor important for you to achieve the inflation target? What is
the drawback of using a nominal anchor?
(b) Suppose the inflation rate in the US is currently 2% and you adopt an exchange rate target
relative to the US dollar. Compute the percent appreciation/depreciation in the lira needed
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for you to achieve your inflation target. Will the lira appreciate or depreciate relative to the
US dollar?
(c) Your final option is to achieve your inflation target using interest rate policy. Using the Fisher
equation, compute the current nominal interest rate in your country. What nominal interest
rate will allow you to achieve the inflation target?
Exercise Both advanced and developing economies have experienced a decrease in the inflation
since the 1980s. This question considers how the choice of policy regime has influenced such global
disinflation. Use the monetary model to answer this question.
(a) The central bank of Lithuania maintains an exchange rate band relative to the euro. This is a
prerequisite for joining the Eurozone. Lithuania must keep its exchange rate within ±15% of
the central parity of 3.4528 litas per euro. Compute the exchange rate values corresponding
to the upper and lower edges of this band.
(b) Suppose PPP holds. Assuming Eurozone inflation is currently 2% per year and inflation in
Lithuania is 5%, compute the rate of depreciation of the lita.
(c) Will Lithuania be able to maintain the band requirement? For how long?
Exercise Suppose a country has decided to peg to the euro. Explain what will need to happen if
the European Central Bank engages in a temporary increase in money supply.
Exercise Explain how each of the following transactions generates two entries – a credit and a
debit – in the US balance of payments accounts, and describe how each entry would be classified
using the exact notations used in the textbook.
(a) You buy $10,000 worth of stocks of a Spanish olive oil firm. In order to complete your purchase
you send a check to the Spanish bank BBVA.
(b) You go to Stockholm and spend $150 for a dinner at a nice restaurant. You pay with your
American Express credit card.
(c) You send a check for a $300 donation to a Haitian charity to help the families affected by the
2010 earthquake.
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(d) A foreign investor in London decides to buy $50,000 worth of US Treasury bills and pays by
drawing down his bank balances in his UK bank.