Exercise-04-solution

ExerciseFour:MonetaryApproachtoBalanceofPaymentsandtheothers1.Accordingtotheequation(4.24),findoutthe(short-run)effectofthefollowingcasesonthebalanceofpayment(overallbalance)?AssumethatnominalGDPisinitially$100billion.(foreignpricelevelisfixed)1)Thecentralbankdecreasesdomesticcreditby1%.2)Domesticoutputgrowsby$1billion.Answer:theequation(4.24)isCDYPEREFˆˆˆˆˆ*1)Whenthecentralbankdecreasesdomesticcreditby1%,itmeans%1ˆCD,thenthechangeofthebalanceofpaymentdependsontheexchangerateregime.Incasea,theexchangerateisfixed,thentheFERmustincreasesby1%,whichrelatestoanimprovementofoverallbalance.Incaseb,theexchangerateisflexible,thentheFERremainsandtheoverallbalanceiskeptbecausetheexchangeratewillabsorballtheshock.2)Whendomesticoutputgrowsby$1billion,Yincreasesby1%.Alsotherearetwopossiblescenarios.Intheenvironmentoffixedexchangerate,theFERmustincreasesby1%andthentheimprovementofoverallbalance.Incaseofflexibleexchangeratetherewillbethesameresultas1).2.ThinkoftheMonetaryApproachtoBalanceofPayments,thedifferenceinmoneymarket(disequilibrium)willresultintheBalanceofPayments.Sothebalanceofpaymentscouldbeexpressedasthefunctionofthegapbetweentheactualcurrentmoneysupply,M,anddesired(long-run)money,Md.AndMdisproportionaltonominalGDP.PYvMMMFERdd1),(1)UsingBPtorepresentthebalanceofpayments,whichisequaltothenominaltradebalanceintheassumedabsenceofcapitalflows,expressitasafunctionofMandPY.Whatistheeffectof∆Mon∆BP,andwhy?Answer:ThebalanceofpaymentsisequaltoBP(M(1/)PY)Anincreaseinthemoneysupplywillthenleadtoabalanceofpaymentsdeficit.Thisoccursbecausethereisanexcesssupplyofmoney,someofwhichisspentabroad.2)AssumeP=EP*,thenwhatistheeffectofadevaluation∆E,onthebalanceofpaymentsintheshortrun?Inthelongrun?Answer:BP(M(1/)EP*Y)Intheshortrun,BP/E(/)P*Y0,thusadevaluationresultsinanincreaseinBP.Inthelongrun,thebalance-of-paymentssurplusmeansthatthemoneysupplyisincreasing.SinceBP/M0,thisincreaseinthemoneysupplyreducesBPuntilBP0.3.MultipleChoice.1)Underfloatingexchangerates,theexchangerateadjustssuchthat(a)thecentralbankhasmetallexcessdemandorforeignexchange.(b)thereisabalanceofpaymentsdeficitafteradevaluation.(c)theeconomyisatafullemploymentoutputlevel.(d)thecentralbankmustexhaustitsforeignexchangereserves.(e)thebalanceofpaymentsiszero.Answer:(e)2)Whichofthefollowingareexpenditure-switchingpolicies?(a)Pricedeflation.(b)Importtariffs.(c)Directbarrierstotrade.(d)Alloftheabove.(e)(b)and(c)only.Answer:(d)3)Internalbalanceisasituationwhere(a)tradeisbalanced.(b)outputexceedspotentialoutput(c)nationalsavingsiszero.(d)outputisatthefull-employmentlevel.(e)noneoftheabove.Answer:(d)4)Theassignmentproblemreferstothe(a)theproblemdeterminingwhetherapolicyisexpenditure-switchingorexpenditurereducing.(b)theproblemdeterminingwhethermoreoutputleaksoutofaneconomythroughsavingsorthetradedeficit.(c)theproblemdeterminingwhichpartofgovernment,thecentralbank(withcontrolovertheexchangerate)orthetreasury(withcontroloverfiscalpolicy),isresponsibleforinternalbalance.(d)theproblemassigningthecauseofatradedeficitascrowding-outoradevaluation.(e)noneoftheabove.Answer:(c)5)Theterm“sterilization”inthemonetaryapproachtothebalanceofpaymentsrefersto(a)changesinthepricelevel.(b)changesinthemoneysupply.(c)theeffectsofmoneysupplychangesontheexchangerate.(d)centralbankactionsthatpreventreservechangesfromalteringthemonetarybase.(e)noneoftheabove.Answer:(d)6)Ifacountry’sinternationalreservesfallby$200million,andtheirnetdomesticassetsincreasesby$100million,thentherewillbeachangeinthebalanceofpaymentsof(a)$100million.(b)$200million.(c)0.(d)$100million.(e)$200million.Answer:(e)7)Acentralbankwishestosterilizeareserveoutflow.Whichofthefollowingachievethisgoal?(a)Expandnetdomesticassetsatthesamerateasthereserveoutflowiscontractingthemoneysupply.(b)Reducenetdomesticassetsatthesamerateasthereserveoutflowisexpandingthemoneysupply.(c)Useopenmarketoperationstoselltreasurysecuritiesontheprivatemarket.(d)Useopenmarketoperationstoreducedomesticmoneysupply.(e)Enlistthehelpofthefiscalbranchtocreateexpenditure-switchingactivities.Answer:(a)8)Inthemonetaristsmall-countrymodel,anexogenousincreaseintheworldpricelevel(a)leadstoahigherdomesticpricelevel,anincreaseindomesticmoneydemandandatemporarybalance-of-paymentssurplus.(b)leadstochangesinthedomesticeconomythroughchangesinrelativepricesasintheelasticityapproach.(c)leadstoalowerdomesticpricelevel,adecreaseindomesticmoneydemandandatemporarybalance-of-paymentssurplus.(d)leadstoahigherdomesticpricelevel,andecreaseindomesticmoneydemandandatemporarybalance-of-paymentsdeficit.(e)(a)and(b).Answer:(a)