Elements of Macroeconomics: Homework #8

[Pages:9]Elements of Macroeconomics: Homework #8

Name:____________________ Section:____________________ Due 12/2 or 12/3 in assigned Section Part A (10 points, 1 point for each question) 1. The amount of one currency you can exchange for another is called the exchange rate.

2. Purchasing Power Parity exchange rate: The exchange rate that lets you buy the same amount of stuff for a specified amount of money.

3. The Big Mac index says the Chinese yuan is undervalued by 47%.

4. The US has consistently had a deficit, in its goods and services account. That means it has consistently run a capital account surplus. These accumulated net foreign inflows have increased the size of its net debtor position.

5. The US net debtor status is a measure of the mismatch between US ownership of foreign assets versus the ownership of US assets by the rest of the world.

6. The real exchange rate is the product of the nominal exchange rate and the ratio of prices between the two countries.

7. Central banks can use monetary policy to guide their exchange rate.

8. Changes in unit labor cost is roughly calculated as such: hourly wage rates ? output per hour

9. Germany, paranoid about inflation, insisted the European Central Bank must operate on Bundesbank principles.

10. The trade weighted dollar uses weights to each currency based on the dollar value of its exports to the US to get a weighted average value of the dollar versus a basket of other currencies.

Part B (34 points) Based on the information given below, answer the following questions.

Mexico's real GDP = 18 trillion Mexican pesos US GDP = 20 trillion dollars 1 US dollar buys 20 Mexican pesos 1 Big Mac costs 5 US dollars 1 Big Mac costs 50 Mexican pesos The US population in 2019: 330 million The Mexican population in 2019: 130 million

1. One Wall Street analyst uses the data above to claim that per capita real GDP in the U.S. economy is about 9 times as large as per capita GDP in Mexico. Reproduce this analysis. (4)

20 trillion USD / 330 million = US real GDP per capita 18 trillion MXN * (1 USD / 20 MXN) / 130 million = Mexico real GDP per capita

20 330

?

18 20

130

=

2600 297

=

8.75

9

2. A different Wall Street analyst uses the data above to claim that the per capita real GDP in the U.S. is only about 4 times the size of per capital real GDP in Mexico.

a. What concept does the analyst invoke to come to this conclusion? (3)

Uses purchasing power parity exchange rates instead of the market's nominal exchange rate.

b. Reproduce the analyst's results. (3)

20 330

?

18 10

130

=

1300 297

=

4.38

4

3. Suppose Argentina suddenly discovers a giant reserve of oil. The U.S.'s large demand for oil causes Argentina's trade surplus with the US to soar. a. What happens to the US demand for the Argentine currency (the Argentine peso or ARS)? (4) Demand for the Argentine peso will increase b. What happens to the value of the ARS versus the US dollar, if all other things remain the same? (4) The value of the ARS will rise relative to the US dollar.

4. Assume that 60 Argentine pesos buy 1 dollar, before the discovery. Using supply and demand curves, depict the shifts in the Argentine peso price of the US dollar, from its original value to its new value after the surge in the trade surplus. (4)

5. Now suppose the Argentine government, fearing the likely effects of their discovery of oil on their currency, and on the implications of this possible currency movement on other exports, directs the Central Bank of the Argentine Republic to peg its value versus the US dollar at is pre-discovery exchange level. Draw the needed shifts in the supply and demand curves in a new graph to depict the Argentine central bank policy in the Argentine peso market. (4)

6. Suppose the Argentine central bank, before the oil discovery, was targeting Argentine real short-term government bond rates (For simplicity, let us call this the t-bill rate). Assume the target t-bill rate was 5%, and that inflation expectations were 3%. The Argentine budget deficit in both 2018 and 2019 is 2000 billion pesos, all finance in the t-bill market.

a. First, consider monetary policy in 2018, before the oil discovery. On the chart below, depict the demand for funds from the Argentine government and the monetary policy action taken by the Argentine central bank, to meet their target interest rate. (4)

r

10 9 8 7 6 5 4 3 2 1 0 0

Supply

500 1000 1500 2000 2500 3000 3500 4000 Q

Buy 1000 t-bills

b. In 2018, the Central Bank of the Argentine Republic must buy t-bills to put pesos into the system, to prevent any appreciation of the pesos. Suppose they must buy 500 billion pesos. Directionally, what would you expect would happen to t-bill rates? Draw the effects on the chart below. What is the new t-bill rate? (4)

t-bill rates will fall.

New real t-bill rate is 1%. Nominal t-bill rate is 4%

Refer to the graph in question a.

Part C (28 points, 4 points for each question)

Assume US real GDP, Q4:2019 equals $20.5 trillion, US NX = -$0.5 trillion. Assume US real GDP growth rate, without a stimulus equals 2%. (1% from productivity increases and 1% from growth in the labor force) Assume US growth rate for domestic spending (realGDP-NX), if no stimulus is enacted, is also 2%. Assume U = 3%, =2% and assume U = 3%, end-of-year 2020, if there is no stimulus.

Suppose Congress is successful in passing a bill that increases infrastructure spending by $300 billion. Assume the multiplier on domestic spending is 2 from the enacted fiscal policy changes. (In other words, for this analysis, assume the policy changes drive domestic demand; Y-NX). Assume the effects of the policy, enacted at the end of 2019, occur over the four quarters of 2020.

(Note: Filling in the table below may help you, as you sort out the questions below)

2019: Q4

Y (real GDP, $ trillions)

20.5

NX (net exports, $ trillions)

-0.5

Y-NX (domestic demand,

21

$ trillions)

Y, Q4:20/Q4:19

Labor Force, Q4:20/Q4:19

Labor Productivity, Q4:20/Q419

U3 (Unemployment Rate)

3%

(CPI Inflation)

2%

2020: Q4 No stimulus

21 (=20.5 * 1.02) -0.5 21.5

3%

2020: Q4

With stimulus

21+0.6 -0.5

21.5+0.6

1. If no policy is enacted what is the level of domestic spending in Q4: 2020?

$21.5 trillion

2. If the policy occurs, what is the level for domestic spending in Q4:2020? What is the growth rate for domestic spending between 2019 Q4 and 2020 Q4?

Level of domestic spending in 2020 Q4: $22.1 trillion Growth rate of domestic spending: [(22.1-21)/21] * 100 = 5.24% or 5.2%

3. Suppose the boom for US spending is not matched by an acceleration for spending in the rest of the world. Likewise, the boom lifts US interest rates, but rest-of-world interest rates stay steady.

a. What do you think happens to the dollar?

Capital inflow causes the dollar to appreciate. The price of the dollar in terms of foreign currency goes up.

b. What will the changes in relative spending rates likely do to the growth of US imports?

The increase in US spending will cause US imports to increase.

c. What will the change in the trade-weighted dollar likely do to growth in US exports and the growth of US imports?

Exports decline and imports increase since the price of US exports has increased and the price of US imports has decreased.

d. Given the dollar's move, and the different spending rates, would you expect US real GDP to grow at the same rate as US real domestic demand? Explain.

Given the dollar's move and different spending rates, the NX deficit will likely rise. So the US real GDP must be growing at a slower rate than US real domestic demand.

4. Suppose the US NX deficit is -$1 trillion in 2020 Q4. What is the level and the growth rate for US real GDP in Q4 2020?

US real GDP in 2020 Q4 after the stimulus: 22.1 -1 = 21.1 Growth rate of US real GDP: [(21.1-20.5)/20.5] * 100 = 2.9%

Part D (28 points, 4 points for each question) Suppose that Toyota (a company in Japan) and Volkswagen (a company in Germany) are competitors in the car manufacturing market. They both sell a car in their domestic market as well as export it to other countries.

Suppose to create one car, both companies need 10 workers working for 8 hours per day for 20 days. As labor productivity increases the number of cars created with the same labor.

In 2019 the exchange rates are given as such: 1 Euro = 110 Japanese Yen

1. Suppose in 2019, the hourly wage is 10 Euros per hour in Germany and 1200 Japanese Yen per hour in Japan. How much does it cost for Toyota and Volkswagen to create one car?

Toyota: 1200 * 8 * 20 * 10 = 1,920,000 Yen Volkswagen: 10 * 8 * 20 * 10 = 16,000 Euros

2. In addition to assumptions above, suppose the domestic price of the car is equal to the production cost of the car and Toyota and Volkswagen only sell in their domestic markets. If Volkswagen decided to export their cars to Japan, how much would the car cost in Japanese Yen?

16000 * 110 = 1,760,000 Yen

3. Assumptions above remained. Will the demand for Toyota cars in Japan be affected by Volkswagen's decision to export to Japan? To simplify the question, assume that the cars created by Volkswagen and Toyota to be perfect substitutes.

Yes. The demand for Toyota cars will fall since the price of Volkswagen cars are lower.

4. Assumptions above remained. Suppose the labor productivity of Japan increased by 20% while Germany's labor productivity remains the same. For Toyota, how many hours does it take to create one car? What is the new price of a Toyota car? What will happen to the demand compared to question 3?

1600 hours / 1.2 = 1333 hours 1200 * 1333 = 1,599,600 Yen Demand for Toyota cars will be recovered

5. Assumptions above remained. Suppose that the European Central Bank decides to increase the supply of Euros so that the exchange rate between the Euro and Japanese Yen becomes 1 Euro = 95 Japanese Yen. How will this affect the price and demand of Volkswagen cars in Japan?

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