Final exam International Macroeconomic Policy SEESGS79 UCL SSEES Time: Two hours Calculators are not permitted Instructions: Answer any THREE questions in section A (do not answer more than THREE questions). Answer ONE of the questions in section B. Answer ONE of the questions in section C. Section A is worth 36% of the final mark, section B is worth 32% of the mark, and section C is worth 32% of the mark. Section A (36 points): Answer any THREE of the following questions (do not answer more than THREE questions): State whether the following statements are true, false or uncertain and provide a short explanation carefully justifying your answer. Marks are only awarded for the justification (argument, algebra, graphs etc.) that you provide. 1. An increase in the probability that a central bank will raise its interest rate next year appreciates the exchange rate today. (12 points) 2. Monetary policy is not effective for countries that choose a floating currency regime. (12 points) 3. In the first-generation model of speculative attacks, accumulating central bank reserves is a way to protect a country against speculative attacks. (12 points) 4. According to the second-generation model of speculative attacks, it is possible to deter speculative attacks by making the fixed exchange rate regime a legal, Constitutional, feature. (12 points) 5. The only way to ensure inflation is low in a country is to appoint a central banker who is willing to trade-off high unemployment against a small reduction in inflation. (12 points) CONTINUED Section B (32 points): Answer the following questions: 1. Real exchange rate model. Assume the Home country and the USA are the only two countries in the world. The Home country’s currency is the Peso. The Peso is pegged to the US dollar with exchange rate 1 US dollar = E Pesos (an increase in E is a depreciation of the peso). Also assume firms in the non-tradable sector in the Home country require labour LN to produce non-tradable goods sold at price PN (in pesos). Firms in the tradable sector require labour LT to produce tradable goods sold at price PT (in pesos). In addi
tion, the Home country produces a large quantity of oil O, with price, in USA dollar, pO. Oil production does not require any labour. a. Define the real exchange R. When does the real exchange rate appreciate (3 points). b. In the Home country, workers can move freely, working either in firms in the non-tradable sector or in firms in the tradable sector. What does that imply for the wage in the non-tradable sector WN (4 points) c. Without proving these relationships, explain how and why the supply of non- tradables depends on the real exchange rate and how and why the supply of tradables depends on the real exchange rate. (5 points) d. Without proving these relationships, write how and explain why the demands for tradables and non-tradables depend on the real exchange rate and on the economy’s national income Y. (2 points) e. In a chart with Y on the horizontal axis and R on the vertical axis, draw, and explain how you draw them, the locus representing the internal balance and the locus representing the external balance. (8 points) f. Suppose the price of oil collapses. What does this fall in the price of oil imply for the current account and for the external balance schedule (and why) Using the chart constructed for question (c), what does this oil price collapse imply for the real exchange rate and income. Which policies should a government adopt to limit the effect of ongoing and future oil price shocks on the economy (10 points) Section C (32 points): Answer the following two questions: 1. Mervyn King, former governor of the Bank of England, once famously noted: “Central banks are often accused of being obsessed with inflation. This is untrue. If they are obsessed with anything, it is with fiscal policy.” Explain why this may be the case. (32 points) 2. “There was a real fear that a euro-zone bank might fail, that we’d have a sovereign debt problem in one of the larger European economies. That’s dissipated, thanks largely to the action of the European Central Bank.” (G. Osborne). Explain which ECB policies were taken and how they relate to the theories of speculative attacks. (32 points)