ECON3602 A-37927_Nov 02exam_File01

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Economics

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Jan 9, 2024

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Midterm (35% of the final grade) ECON 3602 - International Monetary Problems Fall 2023 Instructor: Rashid Nikzad  You have 2 hours to complete the exam.  The exam is closed book. You may use a non-programmable calculator.  The midterm accounts for 35% of the final grade. Please write clearly.  You must upload your exam on BrightSpace. Do not email me your exam as it may not be marked. Question 1 . Write the expression for the uncovered interest parity (UIP) and covered interest parity (CIP). Assume the home currency is dollar ($) and the foreign currency is euro (€) (Note: write the full versions not the simplified versions). (4 marks) What is the difference between them? (1 marks) Answer 3 of the following 5 questions. Only the first 3 answers will be marked. Indicate clearly which question you are answering (Question 2, 3, 4, 5 or 6): Question 2. Consider an investor seeking to invest in France. Using the UIP condition, explain how each of the following would affect the value of the euro and U.S. dollar. 2.a. A decrease in U.S. interest rates (3 marks) 2.b. An increase in France’s interest rates (3 marks) 2.c. A decrease in the expected future exchange rate, $/€ e E (4 marks) Question 3. (a) Write down the equation for the absolute purchasing power parity (PPP) and explain what it means for the exchange rates. (5 marks) (b) Write down the equation for the relative purchasing power parity (PPP) and explain what it means for the exchange rates. (5 marks) Question 4. Describe how each of the following factors might explain why PPP is a better guide for exchange rate movements in the long run versus the short run: (i) transactions costs, (ii) nontraded goods, (iii) imperfect competition, (iv) price stickiness. As markets become increasingly integrated, do you suspect PPP will become a more useful guide in the future? Why or why not? (10 marks, 2.5 marks for each sub-question) Question 5. Use the money market and FX diagrams to answer the following questions about the relationship between the British pound (£) and the U.S. dollar ($). The exchange rate is in U.S. dollars per British pound $/£ E . We want to consider how a change in the U.S. money supply affects interest rates and exchange rates. On all graphs, label the initial equilibrium point A. Answer this question based on the asset approach in the short run . a. Illustrate how a temporary increase in the U.S. money supply affects the money and FX 1

markets. Label your short-run equilibrium point B and your long-run equilibrium point C . (6 marks) b. Using your diagram from (a), state how each of the following variables changes in the short run (increase/decrease/no change): U.S. interest rate, British interest rate, the exchange rate $/£ E , the expected exchange rate $/£ e E , and the U.S. price level P US . (4 marks) Question 6. Show the exchange rate overshooting by completing the following figures and showing the effect of a permanent increase in home money supply in the short-run and in the long-run. Within this framework, use four different graphs to explain the changes in the nominal interest rate (i), real money balance (M/P), price level (P), and exchange rate (E) in the short-run and in the long-run. Start with the following graph. Suppose money supply increases at time T. Show the changes of the variables over time on the requested graphs. Briefly explain each graph. Graph (b): changes of M/P and i over time (4 marks) Graph (c): changes of P over time (3 marks) Graph (d): changes of E over time (3 marks) 2

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