Midterm Practice

There are 3 parts in this test and you must do all of the questions.

Aids allowed: calculator. You may leave your answer expressed as a fraction or a factorial or power or sum. There are a total of 100 points, so you should allocate approximately 1 minute per point. The points for each question are written in square brackets, e. G.

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, [8 points]. Time may be a factor, so be very careful in allocating your time. Be sure to show your work and reasoning, not Just your answer.Partial credit will be generously awarded, so make sure you try all parts of the questions. Obviously, grades will be higher for more precise, detailed, and focused answers.

Be concise in your answers. Good luck! PART l: Short-Answer Questions (30 points) 1 . [10 points] Can you explain why some economists argue that the large current account deficits in Spain during the last decade are caused by a housing bubble? 2. [10 points] Discuss at least one pro and two cons of government debt accumulation at very low Interest rates. 3. [10 points] The rapid growth of the U.S. Current deficit has sparked vociferous debate ? and fresh research ? among international economists.

Some economists argue that the recent surge in labor productivity growth in the last two decades is the explanation for the large US current account deficit. This surge is viewed as having several important consequences. First, higher productivity growth boosted perceived rates of return on U. S.

Investments, thereby generating capital Inflows that boosted the dollar. Second, these higher rates of return also led to a rise In domestic Investment.Finally, expectations of higher returns boosted equity prices, household wealth, and perceived long-run income, and so consumption rose and saving rates declined. Under this explanation, all of these factors helped to widen the current account deficit. If this is the case, one can argue that the American deficit is sustainable because the U. S. Economy is incredibly productive and remunerative to investors. Provide two arguments against productivity growth as an explanation of the large U.

S. Current account deficits. PART II: Exchange Rates (45 points) . 10 points] A U. S. Dollar costs 7. 5 Norwegian kronor, but the same dollar can be purchased for 1.

25 Swiss francs. What is the Norwegian kronor/Swiss franc exchange rate? 5. [20 points] using a figure describing both the Canadian money market and the asset market, analyze the short run and long run effects of a permanent increase in the foreign money supply. 6. Absolute Purchasing Power Parity (APP). (a) [5 points] Describe the APP exchange determination theory. Provide a mathematical expression for the nominal exchange rate under absolute APP.

B) [5 mints] under the Quantity Theory of Money (QUIT), prices clear the money market. The following money supplies M s and M and money demand functions: Md = KY ?KY* where P is the price level, and Y is the real output. Find the equilibrium price in the domestic and foreign economy that clears the money market. (c) [5 points] Under APP and QUIT, what is the effect of an increase in Y to the nominal exchange rate? Explain the intuition. PART Ill: Quantitative Analysis (25 points) 7.

Consider the two-period small open economy without government expenditures and investment.Let’s denote the endowment each period as Ye , I = 1; 2, and let’s assume that the consumer has access to the international capital market to borrow or lend at the constant interest rate r. Also, assume that + r)= 1. Furthermore, assume that the consumer starts period 1 with a stock Bal of foreign assets. (a) [5 points] Write the two period-by-period budget constraints and the international budget constraint. (b) [5 points] Define the net exports in each period (N Ext , t = 1; 2) and write the international budget constraint in terms of the economy’s net exports n both periods.What does this equation say about the sign of the net exports in each period? (c) [5 points] Let lifetime utility be given by U = In(CA ) + In(CA ). Solve for con assumption in each period.

(Note: Recall that Del(C) = C ). (d) [5 points] Derive the expression for current account in period 1 . (e) [5 points] Imagine that output is equal in both periods: Yell = YE = Y and suppose that the country starts as a net debtor (Bal < O).

What can you say about the current account in each period? 2