ECON 361

Review questions

Weeks- 2&3 materials

1)  Which of the following statements are True or False?

  • The existence of low-interest rates in the advanced nations will lead to excessive lendings to foreigners, mostly to emerging nations.
  • After the 1973-74 oil price shock, there were high wealth accumulations by oil exporting countries.

2)  After the negative oil shocks in the 1970s,  prices increased in the US. As a result, the then Fed Chairman  Paul Volcker conducted anti-inflationary policies which lead to huge increase in USA and world interest rates as shown below. libor1980s.png

What is the impact of an increase in world interest rate on the debtor nations’ debt repayment ability and their current account deficits?

3)  In the graph below, we can see the trade balance in Latin American economies in between 1974-1990. We also know that due to Debt crises in the developing world, the foreign lending to that part of the world almost stopped. trade balance latin america.png

Why do you think the Latin American economies were running trade surpluses in the 1980s?

4)    Based on the following table, please answer the following questions:

debt repayments1

a) Calculate the expected receipt for the creditors.

b) Calculate the secondary price of the outstanding debt.

c)  Under the assumption that the probability of repayment does not change with the debt reduction, should the creditors reduce the debt to $50 billion?

d) If the creditors reduce the debt to $50 billion, then what would be the secondary price of the remaining debt  under the assumption that the probability of repayment does not change with the debt reduction?

5) Sketch a typical debt Laffer curve and briefly explaining what does it show.

6) For the following debt Laffer curve, if the creditors want to maximize the expected repayment of the debt, assuming the current level of debt is D, how much debt reduction they should propose?

debt laffer curfe.png

7)   Based on the following table, please answer the following questions:

debtreduction scenario 2

a) Please calculate the expected debt receipt for the creditors before and after the debt reduction.

b) Also, calculate the secondary price of the outstanding debt before and after the debt reduction.

c) If you were the creditor, would you proceed with the debt reduction or not?  Please, explain.

Week- 4 materials

1) Reinhart & Rogoff claimed that 90% is the threshold level of Gross Public Debt/GDP ratio for both advanced and emerging nations. How they support their claim in their paper? In a few sentences, talk about the descriptive statistics they present as an evidence of the existence of a threshold level.

2)  According to the Reinhart & Rogoff paper, what is the nature of the relationship between Gross Public Debt/GDP ratio and the inflation rate in the economy?  Does the nature of the relation change across emerging and advanced nations?

3): growth and inflation.png

Based on the real growth-inflation rate graph above, do you agree with the following statement or not? ” The graph shows that there is no clear link between real growth and inflation rate until the threshold level of 90% debt/GDP ratio is exceeded.”

4) Assume that you are in a job talk and you are given the following table to make at least three inference (any pattern, anomaly, negative or positive association etc. )  by looking at the descriptive statistics on the table.

egert 2012 critics of reinhart and rogoff

 

Week- 5 materials

1) What is deflation and what do you understand from  deflation trap?

2) Please, fill in the blanks in the following statements:

  • According to the Keynesian saving paradox, if all agents start saving due to precautionary reasons, aggregate demand ___, income, and wages _____, they will try even more to ______, which will further deteriorate income etc.
  • In an IS-LM framework, if the nation faces liquidity trap then the LM curve will be _____________.  Any monetary expansion leave the LM curve ______________.

3) What happens to the production and prices in the economy if firms fear about future profitability and start lowering workers’ wages or firing some?

4)  According to the Bank credit deflation, when banks made some bad loans and face higher credit risk, then they cut back on loans and put more liquid assets in their portfolio to lower their riskiness. What is wrong with this? All banks now less risky than before because all cut back on loans. Please comment on how this will have an impact on the economy.

5) Normally functioning banks are stabilizing the downturns. In recessions, Central Bank lowers the interest rates to boost the demand. Since banks have no trouble on their balance sheet, they will be ready to lower saving rates to distress lending to firms and households. So, households and firms do not need to save more with lower inflation as they have access to easy credit through the normally-functioning banking system.  In the US, just before the start of the global recession in 2007, there was an excessive buildup of debt by the household sector and the banks were in trouble because they made a lot of bad loans. So, please explain why conventional monetary expansions (lowering interest rates) would not be that successful to boost the demand when the banking sector face some serious balance sheet problem.

6) What is meant by “excess capacity” as a justification of observed deflation in the world?

Week- 6 materials

1)  If we see an  economy which observes both rising prices and unemployment at the same time (inflation was rising even though the unemployment rate was rising so output falls. Hence,  inflation and output are negatively correlated), then can we conclude that the upward sloping Phillip’s curve does not hold any more?

2) List at least three temporary shocks that will  have an impact on the expectation-augmented Phillip’s curve (PC) also write if the curve shifts to the left  (upward) or to the right (downward).

3) Which of the following statements are True or False?

  • According to the expectation-augmented Phillip’s curve (PC), there is a one-to-one relation between inflation expectation and inflation because the workers will bargain for higher wages based on the inflation expectations.
  • When real interest rate (r)  is equal to its long run natural level  (r*), then there will be positive output gap  in the economy.
  • Given the monetary policy function below, if the inflation rate is short (lower) of the Central Bank’s target, then the Central Bank will raise the interest rate (i) and boost the money supply.MPfunction

 

 

  •  Given the monetary policy function above, when the inflation rate is just at the target, the nominal interest rate is set to be equal to the natural rate of real interest rate + Central Bank’s target inflation rate.

4) Given the following IS-MP curve, if inflation rate raises over the target value, then what happens to real interest rate and  real income (y)?

IS-MP function

5) Assume that the Augmented Phillips curve takes the following explicit form:

takehomeQ1

a)   Draw a graph for the Phillip’s curve when the temporary inflation shock is zero; put inflation rate on the vertical axis and mark the y* on the graph as well as the vertical and horizontal intercepts.

b)  If y*=8 and y=6, find the corresponding inflation rate in the economy when inflation shock is assumed to be zero.

c)  Now, assume that the economy observes a positive temporary inflation shock as on the right:takehomeQ2.png  What will be the immediate impact of this shock on the Phillip’s curve?

6) The IS-MP and PC curves are given as follows:IS-MP function

augmentedPC.pngtakehomeQ2A.png

a)  In the absence of an aggregate demand shock, draw the IS-MP curve by putting inflation rate on the vertical axis.

b) For the parameter values given above, calculate the nominal interest rate in the economy when  y=15.

c) If current income decreases from 15 to 10, what will happen to nominal interest rate and the inflation rate in the economy?

Week- 7 materials

1) Assume that the country functions based on the IS-MP-PC model with adaptive inflation expectation and, as shown below, it is initially at its long-run equilibrium point with actual inflation=expected inflation= Central Bank’s target rate of inflation. Analyze the impact of a one-time (temporary) decrease in aggregate demand on the inflation rate and output in the economy.

ISMPPC long run equilibirum.png

2) The augmented-Phillips curve takes the following form:

augmentedPC.png

MPfunction

The monetary policy function has the standard assumption that the inflation gap coefficient is bigger than unity.  If the inflation expectation rises for whatever reason, then what happens to real income (y) and real interest rate (r) in the short run?

3) Do you agree or disagree with the following statement: “Given the monetary policy functiMPfunctionon on the left,  if the economy observes a recession  with falling income and prices, then the central bank should  lower the  interest rates to boost the demand.”

4) The expectation-augmented Phillip’s curve under adaptive inflation expectation formation takes the following:

PC under adaptive expectations

Then, what can you say about the expected relationship between change in inflation rate and the change in the unemployment rate?

5)  Why there is a zero bound on interest rates?

6) Given the monetary policy function as follows:MPfunction

Find the       ZLB inflation      for the following explicit MP function:

explicit MP function

7)  Assume that the interest rate hits the zero lower bound in the economy and also assume that the inflation expectations are formed adaptively; people look at the last period’s inflation data when they form their expectation for the future.  What do you expect output and unemployment to be if there is a one time decrease in inflation expectation? ( Hint:  First, decide if you are  on the downward-sloping or upward sloping part of the IS-MP curve, then  see what happens to Phillip’s curve after a decrease in inflation expectations. Under adaptive inflation expectation, a(n) decrease (increase) in inflation rate will  lower (raise) the inflation expectation.)

Week- 8 materials

1)  If we believe that the world real interest rate is being determined by global desired savings=global desired investment spending equilibrium condition (the market for loanable funds), then what do you expect to happen to world real interest rate and equilibrium level of global savings and investment levels if…..

  1. a)    There is a temporary decrease in world oil prices
    b)   All countries in the world start running more budget surpluses
    c)    Major countries in the world experience a recession with falling income levels.

2)    By using the market for loanable funds market for world real interest rate determination (on a graph), show the impact of increase regulations and the high carbon tax on production on the world real interest rate and equilibrium levels of global savings and investment spending.

3)     Please comment on the following graph (Figure 2):(Note: working-age population growth for the world is GDP-weighted)

figure2
4)     In the scatterplot below (Figure 4), we have the world investment and savings (%GPD)  ratios vs. world real interest rate data.  What type of shocks (demand or supply shocks in the market for loanable funds) do you think the world economies have seen in between 1979 to 1983 so that savings and investment ratios have fallen while there was an increase in the world real interest rate?

Figure4

Week- 9: Exam time

Week- 10 materials

1)  –What do you understand from the following phrase:  “….  a tight labor market generates higher inflation…”

2) If the Phillip’s curve takes the following form  with unemployment rate on the horizontal axis and the economy moves from point A to point E, then can we conclude that the inflation expectations are formed adaptively?

PC simple with u static inf expectations

3) Do you agree or disagree with the following statement:    “If the inflation expectations are formed adaptively and the economy is in a stagflation era (high inflation and high  unemployment), then disinflation policies will be less costly to the economy because any contractionary monetary policy will bring down the inflation rate, hence, people lower their inflation expectation, it will create downward shifts on the Phillip’s curve, therefore, the country will face  lower trade-off.”

4) Since the beginning of the Great Recession, is there a low or high inflation problem in the United States?

5) Please explain how increasing globalization might contribute to the flattening of the Phillip’s curve.

6) data on adaptive inf.png

Given the graph above, in which period we have more evidence of adaptive inflation formation?

7) Do you agree or disagree with the following statements:

a) If the Phillip’s curve is flatter, then the central bankers face a higher trade-off to lower the unemployment gap.

b) If the Phillip’s curve is flatter, then the central bankers face a lower trade-off to reduce the high-level inflation to a lower level.

c) A flatter Phillip’s curve means that the domestic prices are now more sensitive to the domestic demand conditions.

Week- 11 materials

1)  If the economy is highly connected to international markets is  it good or bad to have a flexible exchange rate regime

2) Suppose that two countries, Germany, and USA, grow tomatoes. Germany uses the euro, USA uses the dollar. In Germany, tomatoes sell for   4 EURO per kilo.  In the USA, it is $5 per kilo. The exchange rate is E€/$  = 0.95.

a) A Germany tourist in New York, let’s name him Hans, wants to buy 6 kilos of tomatoes from a local grocery shop that is next to an exchange office where you can exchange euro for the dollar at the spot market rate. How much euro does Hans need to exchange for a dollar to buy that much of tomatoes?

b) Hans returned back to Germany but he has only dollar in his pocket. Hans went to a German grocery shop, next to an exchange office  where you can exchange dollar  for euro at the spot market rate,  to buy 2 kilos of tomatoes. How many dollars Hans need to convert to the euro to buy that much of tomatoes?

3)  Given the information in Table below, calculate the relative price of US Big Mac in terms of Japanese Big Mac in 2014 and 2015 and tell which country gets relatively cheaper.

bog mac

4)    Assume that Turkish economy adopts a fixed exchange rate regime (fixed against the dollar) with the following par value:  $1= TRY 2.5.  If, for some reason, real income in Turkey rises significantly, what would be the pressure on the Turkish lira and what type of intervention is needed by the Central Bank of Turkey to defend the exchange rate regime and as a result what will happen to the money supply in the nation.  Please show your answer (with arrows) on the following  T-chart of the central bank.

t chart

5) If a country under a fixed exchange rate regime faces downward pressures on the value of their currency (the country’s currency tends to depreciate in normal market conditions), then…..

  •  What would be the proper central bank intervention to defend the currency at the par value?
  • What will happen, after the central bank intervention, to the composition and size of the assets of the central bank balance sheets?

6) Is there any devaluation risk under the currency board exchange rate regime?

7) If Turkey adopts a strict currency board regime by setting lira to US dollar at a fixed rate of $1=2 TRY, then for every 2 TRY out in circulation, the central Bank needs to hold $1 in their reserves. This system necessitates that  the interest paid on dollar-denominated saving deposits to be equal to the interest paid on lira-denominated savings in the nation. Assume that there are some domestic problems in Turkey with high unemployment and inadequate demand and the country’s monetary authority wants to inject lira to the system to lower the interest rate and boost the demand. What do you expect to happen on people’s desire to hold lira vs. dollar in their portfolio?

Week- 12 materials

1)  If Turkey is pegging to Dollar and receiving a lot of foreign capital (huge capital inflow), then, what will happen to the real exchange rate in Turkey if we define real exchange rate as the relative price of US basket of goods and services in terms of Turkish basket of goods and services?

2)  Assume that Turkey is under a fixed exchange rate regime and a major recipient of capital flow from abroad. What type of pressure does the lira face with massive capital inflows?  What type of intervention is needed by the central bank and what will be the corresponding impact of the intervention on Bank reserves and potentially on the money supply in the nation?

 

3)  If the real exchange rate is constant for Turkey, then what do you expect the relation between inflation in US and Turkey to be  if Turkey pegs to the dollar?

4)  Assume Turkey pegs to the dollar (official rate is $1= TRY2.75 )  and interest rates on lira and Dollar-denominated deposits in the nation are same and equal to 5%.  Also, assume that people of Turkey suddenly want to hold more lira (say due to an increase in real income in the nation). The money demand increase raises the  interest on lira-denominated deposits to say 5.1% and the value of lira in the private foreign exchange market  increases to E_(lira/$)=2.74.   Given this arbitrage opportunity  in the market, how much money you can make with  1 million lira?

5) If a country pursues independent monetary policy along with fixed exchange rate regime, then explain why that  nation cannot  have freely floating capital markets with no capital controls.

6)   Assume that the U.S. interest rate is 5%, the European interest rate is 2%, and the expected exchange rate in 1 year from now  is $1.15 per one unit of €.

a) If the current exchange rate is equal to $1.10 per  one unit of €, then does the interest parity condition hold?  If not, then, which currency offers a better  gross return when measured in one common currency?

b)  At approximately what exchange rate, will the returns between the United States and Europe be equalized?

7) Assume that the central bank of Turkey has the following balance sheet.  Also assume that Turkey adopts fixed exchange rate regime against the US dollar with a par value of $1=1 TRY.

Assets Liabilities
Domestic assets=800 billion lira Currency= 700 billion lira
Foreign Assets =400 billion lira Reserves=500 billion lira

Now, assume that the lira is under downward pressure, the central bank needs to intervene to eliminate to pressure to defend the currency regime and they need to intervene in the market by selling $50 billion to the market.

a) Show the impact of this intervention on the balance sheet of the central bank.

b) If the Central bank wants to sterilize this intervention, then what they need to do? Please show the balance sheet of the bank after  the sterilization.

8) If a country pursues fixed exchange rate regime with strict capital controls,  then explain how that  nation can  fight with unemployment problem (via monetary expansion) without endangering their fixed exchange rate regime?

9)  If a country pursues  independent monetary policy and they are fully integrated with the rest of the world with no capital controls, then explain why that  nation cannot  pursue fixed exchange rate regime?

Week- 13 materials

1)  Keeping all other things constant,  if the Central Bank of Turkey starts selling dollars to the market to slow down the depreciation of Turkish Lira, then what happens to the  following variables in  Turkey:

a) Official financial outflows

b) Official financial inflows

c) Net official financial flows

d) Monetary aggregates in Turkey

2)  Answer the questions below based on the following table:

official interventions

a)   If Canada wants to increase their trade surplus against the US and intervenes in the foreign exchange market by buying USD with Canadian Dollar, then what do you think will happen to the Mexican trade to Canada and the USA?  Also, what do you expect to happen to jobs and employment in Canada and the USA?

b) If the US wants to retaliate the currency manipulation of Canada made in part (a), then what they need to do in the foreign exchange market?  As a result, what will happen to US net official  financial flows?

3) Assume that we have just two countries on earth: USA and Canada. They trade to each other, there are free flows of capitals across borders, both nations pursue independent monetary policies because both nations pursue floating exchange rate regime. Given the information below, please answer the following questions:

game theory.png

Assume that both Canada and the US entered into a severe recession with huge production and income loss. Also assume that both nations hit the zero lower bound, so the monetary policy is not an option. The fiscal policy is the only tool they can use to change the aggregate demand.

a) If only the US conducts expansionary fiscal policy, then what do you expect to happen to the trade balance of Canada and the US? What will happen to the jobs and employment in both countries?

b) Assume that Canada will pursue contractionary fiscal policy and the US  government knows this fact for sure. If the only concern for the US government is to prevent their trade deficit from rising, then what will be the best fiscal policy for the US  in response to contractionary fiscal policy in Canada?

c) Explain why expansionary fiscal policy by both nations will be a win-win situation for both nations?

4)  If there is excess supply, low growth and high unemployment in the both the domestic and the neighbor countries and the domestic country conducts monetary expansion, then what do you expect the net impact of this monetary easing in the trade balance of the neighbor country?

5)  If we define the spillover effect as the impact of a change in the domestic country’s monetary policy on the neighbor country’s trade  balance ( the two major channels are income effect and expenditure-switching effect), then

a) If Canada pursues contractionary monetary policy, what do you expect to happen to the US trade balance via income channel

b) If Canada pursues expansionary monetary policy, what do you expect to happen to the US trade balance via expenditure-switching channel?

Week- 14 materials

1)  Assume that Turkey targets Nominal GDP as their policy instrument. If the economic growth in Turkey is lower than usual, then, should the Central Bank of Turkey keep the inflation rate higher than or lower than the usual?

2)  Assume the followings:

Turkey targets 2% Nominal GDP growth rate and currently has zero output gap.

New Zealand targets 2% inflation rate and currently has zero output gap.

Canada targets 0% output gap and currently has zero output gap.

If all three countries face a significant aggregate demand decline through investor confidence fall, and both inflation and GDP fall by 1% in each country, then, by using the AS-AS model:

a) In response to the shock, which country(ies) will have monetary expansion /contraction?

b) Which country do you think will have the largest monetary  growth than the other nations?

c) Which country is more capable of fighting with negative demand shocks in their labor markets?

 

3)  Assume the followings:

Turkey targets 2% Nominal GDP growth rate and currently has zero output gap.

New Zealand targets 2% inflation rate and currently has zero output gap.

Canada targets 0% output gap and currently has zero output gap.

If all three countries face a significant negative supply shock through huge oil price increase, and inflation rises by 2 %and GDP falls by 1% in each country, then, by using the AS-AS model:

a) In response to the shock, which country(ies) will have monetary expansion /contraction?

b) Which country do you think will have the largest monetary  growth than the other nations?

c) Which country is more capable of fighting with negative supply shocks in their labor markets?

 

4) What is a terms of trade shock and give some examples of terms of it?

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s