ECM158 International Macroeconomics Assignment 6th May 2022 This coursework is worth 70 percent of your overall mark. It consists of five equally weighted questions, of which you must answer three and only three. Each question is worth 100 marks, with marks of sub-parts as indicated in brackets. Answers must be submitted as either a Word or a PDF file, with all textual material typed in font size 11 or 12. Mathematical equations and diagrams may be hand- written and inserted as scans but the scans must be clear and the handwriting legible. All mathematical and diagrammatic material should be relevant to and fully explained within the accompanying text. Answer THREE questions 1. (a) Discuss the assumptions of the Swan diagram analysis. (40 marks) (b) Present graphically and discuss the Swan diagram. (60 marks) 2. Consider a small open economy in which there are no restrictions on trade or capital flows but domestic and foreign assets are imperfect substitutes. Suppose the exchange rate is not allowed to float and the economy is initially in IS-LM-BP equilibrium. The Central Bank devalues the currency by surprise. Explain in words and with the help of diagrams how the economy will react (a) immediately (40 marks) (b) over time when it reaches a new equilibrium (40 marks) (c) why is it important that the devaluation is assumed to be by surprise (20 marks) 3. Explain in words (50 marks) and with the help of diagrams (50 marks) the relationship between Spot and Forward Markets. 4. Consider the assumptions of the first generation of exchange rate crisis models, for which the relevant equations describing the economy under the fixed regime are given by where M,D,F represent money supply, domestic credit and f
oreign reserves, i is the interest rate fixed at the foreign rate i*, P is the domestic price and is the fixed exchange rate. 0ba,SPbi-aM/PFDM ==+= S When exchange rates are floating, and in the absence of foreign reserves, the equations are given by where S is the exchange rate and E[.] represents the expectations operator, with expectations assumed to be rational. (a) Show that = 0+0 where D0 , F0 are the initial values of D and F at the start of this increase in domestic credit. (5 marks) (b) Analyse the timing of a speculative attack in this model when domestic credit is growing at a velocity , i.e. D=D0+ t, and verify that under floating, the exchange rate is given by = 0+ + ( )2 (55 marks) (c) By equating the above equation to , show that the time of the attack on the currency is given by = 0 (20 marks) (d) How is the time of the attack affected by changes in F0 and (20 marks) 5. (a) Describe a simplified version of the balance sheet of the banking system, to include gold, foreign reserves, currency, deposits and loans for both the central bank and the commercial banks. Describe also the consolidated banking sector, and explain the relationship to money supply. (25 marks) (b) Explain the key components of the Monetary Approach to the Balance of Payments (MABP), paying particular attention to the current account, changes in money supply, money demand and the aggregate demand schedule. (25 marks) (c) Analyse the effects of a monetary expansion under a fixed exchange rate regime, according to the MABP. (25 marks) (d) What is the key implication of your analysis of (c) that enables a statistical test of the MABP Outline the empirical results. (25 marks) SPiibi-aM/PDM dt dS S * = +=== ][ 1