PART 2 OPEN ECONOMY MACROECONOMICS



EC 2004: INTERNATIONAL ECONOMICS

SAMPLE EXAM TYPE QUESTIONS

PART II: Open Economy Macroeconomics

Balance of Payments:

1. "A current account deficit means that the country’s central bank has sold foreign reserves." Critically discuss the accuracy of this statement with reference to the definitions of current account, capital account and official settlements balance.

2. What are the main categories of a country’s balance of payments and how are they related to each other? What does the principle of double-entry bookkeeping imply about the way in which export earnings enter the overall balance of payments? Illustrate your answer using a specific example of the type that might occur in practise.

Foreign Exchange Markets and Interest Rate Parity:

1. “The expected future spot rate must equal the appropriate forward rate; hence there is no difference between covered and uncovered interest rate parity.” Critically address this statement with reference to spot markets, forward markets and the notion of Interest Rate Parity.

2. Show how behaviour in foreign currency markets can be analysed using supply-demand analysis, making sure to identify which activities contribute to each side of the market. Using this approach, analyse the effects on the equilibrium exchange rate of an autonomous decrease in demand for a country’s exports.

3. Discuss the four levels of activity in foreign exchange markets and show how supply and demand analysis is used to reduce these levels into a single market. In what sense can both spot and forward transactions be carried out at a single level, e.g. the retail level?

The Monetary Model:

1. Explain the difference between Purchasing Power Parity (PPP) and Interest Rate Parity and assess the empirical plausibility of both.

2. Outline Dornbusch's model of exchange rate "overshooting" and discuss its contribution to our understanding of why exchange rates are so volatile. Using this approach analyse the effects of an decrease in domestic GDP on the domestic (i) price level; (ii) interest rate and (iii) exchange rate in both the short and the long run.

3. "Excessive monetary growth leads to balance of payments problems under fixed exchange rates, and a currency problem under floating exchange rates." Discuss this statement with reference to the monetary approach to the balance of payments.

4. a) What are the assumptions underlying the monetary approach to the balance of payments ?

b) Using the monetary model discuss the effects of an increase in domestic income under both fixed and floating exchange rates.

Devaluation and the Marshall Lerner condition:

1. "A devaluation will lead to a immediate deterioration of the current account." Discuss this statement with reference to the Marshall-Lerner condition and the J-curve.

2. “A nominal depreciation is unlikely to lead to a real depreciation and even if it does, the current account is unlikely to respond in a positive way." Critically discuss.

External and Internal Balance and the Swan Diagram:

1. Discuss the concepts of internal and external balance. Show how diagrammatic analysis is used to analyse the effects of expenditure-changing and expenditure-switching policies in attaining these.

2. Distinguish between expenditure-changing and expenditure switching policies and show how the Swan Diagram is constructed in order to analyse the effects of these policies on the macroeconomy. What combination of policies does your analysis suggest when the economy is initially in a recession with a balance of payments deficit?

The Mundell-Fleming Model and the Policy Mix:

1. Outline the Mundell-Fleming model and use it to compare the effectiveness of fiscal and monetary policies at influencing the level of spending on an economy’s output in a small, open economy with perfect capital mobility under floating exchange rates. How would your answer change if the economy were large.

2. In what sense does IS-LM-BP analysis depend on the assumption of a small economy with perfect capital mobility? How does the model change if the country is assumed to be large? Elaborate on your answer by showing how the effects of a monetary expansion under fixed exchange rates differ between a small and a large country.

3. "Under fixed exchange rates, monetary policy should be used to attain external balance and fiscal policy for internal balance; otherwise the economy never reaches balance.” Critically discuss with reference to the policy mix diagram and the principle of effective market classification.

The Choice of Exchange Rate Regimes:

1. Critically analyse the automatic stabiliser argument in favour of letting exchange rates float? Are there other arguments in favour of floating exchange rates? If so, briefly discuss them.

2. Discuss the major arguments about whether a country should fix or float its exchange rate. Why is a developing country likely to gain more from fixing its exchange rate than a developed one and what risk does it face if it chooses to do so?

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