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Assignment 2

The document provides instructions for an individual assignment in International and Monetary Economics. It states that the deadline for submission is April 5, 2023 at 23:59 Milan time and solutions can be submitted in PDF or DOC format. It also notes that the assignment contains 6 problems of equal weight worth 5 points each and the problem set is worth 10% of the final grade. Students should clearly label diagrams and state additional assumptions.

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102 views4 pages

Assignment 2

The document provides instructions for an individual assignment in International and Monetary Economics. It states that the deadline for submission is April 5, 2023 at 23:59 Milan time and solutions can be submitted in PDF or DOC format. It also notes that the assignment contains 6 problems of equal weight worth 5 points each and the problem set is worth 10% of the final grade. Students should clearly label diagrams and state additional assumptions.

Uploaded by

Ra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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30054 International and Monetary Economics (Spring 2023)

Individual Assignment 2

Instructions
When? The deadline to submit your solution is April 5, 2023 (23:59 Milan time).

Where? Upload your solution to the bboard webpage of our class.

What? You can submit your solution in either PDF or DOC format. When drawing
diagrams or writing formulas, you can either use build-in word processing tools
or you can draw diagrams and write formulas by hand, take pictures, and insert
them in your solution.

Who? This is an individual assignment. You must submit an individual solution.

How much? All problems have equal weight of 5 points each. This problem set has a 10%
weight of your final grade.

Be clear. If you make additional assumptions in your solution, state them clearly. Also
when drawing diagrams, clearly label all axes, lines, curves, and equilibrium
points.

1
Problem 1 (Real exchange rate)

1. Suppose the expected real interest rate in Hong Kong is 5 percent per year while
that in Singapore it is 2 percent per year. What do you expect to happen to the
real HK$/SNG exchange rate over the next year?

2. Suppose the expected real interest rate in the United States is 9 percent per year
while that in Europe is 3 percent per year. What do you expect to happen to the
real dollar/euro exchange rate over the next year?

Problem 2 (Debt financed government spending)


Suppose interest parity does not hold exactly, but the true relationship is R = R∗ +
( Ee − E)/E + ρ( B), where ρ( B) is a risk premium on domestic government bonds that
positively depends on B. Suppose a temporary rise in domestic government spending
is financed by issuing additional government debt (an increase in B) and makes do-
mestic public bonds risk premium higher. Evaluate the policy’s output effects in this
situation.

Problem 3 (Shifting curves)

1. Write a mathematical expression for the DD curve introduced in class. Explain


intuitively what the DD curve is.

2. Graphically illustrate what happens to the DD curve in each of the following


cases

(a) government spending G goes down;


(b) nominal exchange rate E goes up;
(c) private investment I goes up;
(d) aggregate output Y goes up.

3. Write a mathematical expression for the AA curve introduced in class. Explain


intuitively what the AA curve is.

4. Graphically illustrate what happens to the AA curve in each of the following


cases

(a) nominal price level P goes down;


(b) money supply M goes up;
(c) nominal exchange rate E goes up;
(d) aggregate output Y goes up.

5. Intuitively explain how you decide on whether a change leads to a shift in a


curve or a movement along the curve.

2
Problem 4 (The Big Mac Index)
The goal of this exercise is to analyze the extent to which the purchasing power of var-
ious currencies against the U.S. dollar implied by Big Mac prices are representative of
larger consumption baskets. To this end, you are asked to compare the real exchange
rate implied by Big Mac prices, which is based on just one good, with the one implied
by the World Bank’s International Comparison Program (ICP), which considers bas-
kets with hundreds of goods. Data for the Big Mac Index for 2017 can be downloaded
from the Economistthe Economist. Price Level data from the 2017 round of the ICP
can be found in the ICP Report, see in particular Table E.3 entitled ‘Individual Con-
sumption Expenditure By Households,’ column ‘Price Level Index (World=100.0).’
1. Let P∗ denote the foreign price level, PUS the U.S. price level, and E the nominal
exchange rate in dollars per unit of foreign currency. Let the real exchange rate
be defined as q = EP∗ /P. Construct two versions of q in 2017, one based on Big
Mac prices, which we denote qBig Mac , and one based on ICP prices, which we
denote qICP . When computing the two real exchange rate scale the data so that
both qBig Mac and qICP equal 100 for the United States. Your dataset should have
as many observations as countries that are both in the Big Mac Index table and
the ICP table.

2. Make a graph displaying qBig Mac on the horizontal axis and qICP on the vertical
axis.

3. Present an insightful discussion of your findings.


Big Mac
4. Then run a cross-country regression of qICP
i onto qi , that is, estimate
Big Mac
qICP
i = α + βqi + ϵi
using ordinary least squares, where the subscript i denotes country i, so each
observation is one country. Report your estimate for β and the R2 of your regres-
sion. Provide a verbal discussion of your findings.

5. Include a printout of the data that went into the construction of your graph.

Problem 5 (Net exports)


1. Intuitively explain the following formula that describes trade balance between
the Euro area and the UK and that was discussed in class
P∗
 
NX = Ex
PImports from EA in Pounds
PImports from UK in Euros
 
∗ P
− · Ex .
P PImports from UK in Euros

2. What is the producer-currency pricing (PCP) assumption? How do changes in


Euro-pound nominal exchange rate E affect NX, Ex, Im in this case?
3
3. What is the local-currency pricing (LCP) assumption? How do changes in Euro-
pound nominal exchange rate E affect NX, Ex, Im in this case?

4. What is the dominant currency pricing (DCP) assumption? How do changes in


Euro-pound nominal exchange rate E affect NX, Ex, Im in this case?

Problem 6 (Krugman’s article)


Read the article by Paul Krugman titled “A country is not a company”. Write a twitter-
length (280 characters max) summary of its main message.

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