Answer any three questions

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SECTION A

MULTIPLE CHOICE QUESTIONS

REQUIRED:

COMPLETE ALL 25 QUESTIONS - EACH QUESTION = 1 MARK

Structure - Section A – topics 1-5

Balance of payment recording

Meaning of the current account balance, the FA balance and the change in IR account

National income accounting and the CA – Savings and Investment relationships

Intertemporal trade – Closed economy interest rate, world interest rates and comparative advantage in future /current consumption

Covered interest parity

Uncovered interest parity

Calculate the spot exchange rate

Calculate the forward exchange rate

Savings / investment and the relative cost of a unit of current consumption

Topic 1- 5 continued

Purchasing power parity

The relationship between the forward Rate and the Expected spot (arbitrage)

The J curve effect

The dornbusch model

The international fisher relationship

The monetary model of exchange rate determination

The elasticities model – market for imports, market for exports

The Absorption model – how does it differ to the elasticities model

SECTION B

STUDENTS ARE REQUIRED TO COMPLETE ANY THREE OF THE FOLLOWING FIVE QUESTIONS.

This section is worth a total of 75 marks.

Topic 5 - Q1

Internal balance – effect of a change in the RER

The swan model -internal and external balance -

Policy assignment to move towards general equilibrium

Automatic adjustment mechanisms – internal and external balance

Topic 6 – Section B Q2 and Q3

Monetary policy – fixed and flexible exchange rates under perfect and zero capital mobility.

Fiscal policy – fixed and flexible exchange rates under perfect and zero capital mobility

Macroeconomic interdependencies’

Fiscal policy under Regressive expectations

Topic 7 and 8 – Q4

Choice of exchange rate regimes and protection against external macroeconomic shocks

External balance adjustment – how does the RER change under a fixed and a floating exchange rate

Currency crisis models – 1st and 2nd generation models

Seen Question – Q5

COMPLETE EITHER PART A OR PART B

PART A

On the 23 of June 2016, The United Kingdom voted to leave the European Union, the outcome of which has been referred to as Brexit. The question of how “Brexit” will affect the UK economy is one crucial issue but the effects are also being felt across world markets. Investors hate uncertainty and the result of the referendum gives rise to much uncertainty. The falls in Asia’s equity markets indicate an early judgment about the impact on the world economy. A big concern is the extent to which Brexit will disturb the world economy.

Consider the experienced and likely economic effects of Britain’s decision to leave the EU on both the,

the UK economy (Domestic)

on the broader Global economy, a UK trading partner or a trading region (Foreign)

Your answer should be an application of theoretical concepts you have studied in this course.

(25 Marks)

Q5 - Part B

“The 2 July 1997 was the day the Thai Government announced a managed float of the Baht and called on the International Monetary Fund (IMF) for 'technical assistance'. That day the Baht fell around 20 per cent against the $US. This became the trigger for the Asian currency crisis.”

Applying what you have learned in this course, particularly in topics 7 and 8, consider the causes of the Asian financial crisis and the outcomes for income levels in the affected countries. You can examine the currency crisis of a particular country or the implications on a number of different countries depending on your interest.

(25 marks)

Rubric is on blackboard Brexit

Asian Financial crisis The Crash Asian crisis

BREXIT

BREXIT is a word that has become used as a shorthand way of saying the UK leaving the EU

A referendum - held on Thursday 23 June, to decide whether the UK should leave or remain in the European Union. Leave won by 52% to 48%. The referendum turnout was 71.8%, with more than 30 million people voting.

THE EU

The European Union - often known as the EU - is an economic and political partnership involving 28 European countries. It began after World War Two to foster economic co-operation, with the idea that countries which trade together are more likely to avoid going to war with each other.

It has since grown to become a "single market" allowing goods and people to move around, basically as if the member states were one country. It has its own currency, the euro, which is used by 19 of the member countries, its own parliament and it now sets rules in a wide range of areas - including on the environment, transport, consumer rights and even things such as mobile phone charges

Timeline to exit

For the UK to leave the EU it has to invoke an agreement called Article 50 of the Lisbon Treaty which gives the two sides two years to agree the terms of the split. Theresa May has confirmed this will be done by the end of March 2017, meaning the UK will be expected to have left by the summer of 2019,

Some useful data sources

OECD data –UK http://www.oecd.org/unitedkingdom /

Four corners Documentary – Battle for Britain Bexit four corners documentary

The Bank of England

Audio clips

Brexit: Reactions from the UK and what it means for Europe

http://www.abc.net.au/radionational/programs/extra/27-june/7542042

Brexit or Bremain? The implications of the UK's EU referendum

http://www.abc.net.au/radionational/programs/bigideas/uk-referendum/7485158

Business and Economics: corporate culture and George Soros

http://www.abc.net.au/radionational/programs/drive/business-and-economics-corporate-culture-brexit-george-soros/7534426

https://radio.abc.net.au/programitem/pgga7dz4r6?play=true

Monetary policy

The monetary policy response to Brexit

“The much-watched barometer of the state of manufacturing, construction and services found that the deterioration in the weeks immediately following the referendum pointed to the economy contracting by 0.4% in the third quarter of 2016.“

Information on UK monetary policy and key indicators can be found here

Bank of England Website

Fiscal policy

What are the options?

Current levels of debt?

WSJ article relating to fiscal policy

Topic 1

Balance of payments;

What are current trends observed in the United kingdoms balance of payments

https://data.oecd.org/trade/current-account-balance.htm

Financing debt

Credit

Debit

Current account (CA)

Merchandise

Services

Primary income (iNFA)

Secondary income (remittances, transfers)

Financial Account (= – ΔNFA)

Foreign assets owned by domestic (FA)

Domestic assets owned by foreigners (FL)

Change in Official Reserves

(= – ΔIR)

Exports

Received

Decrease

Increase

Decrease in R

Imports

Paid

Increase (Buy)

Decrease

Increase in R

Errors & Omissions (Statistical Discrepancy)

= Sum of credits minus sum of debits

Eg. Government borrows by selling Government bonds overseas. UK lost their AAA rating.

Recall: National Income Account

If Sn > I  CA > 0  ∆NFA > 0

Balance of Trade Surplus EX>IM

Current Account Surplus

Net Foreign Asset (Net Foreign Wealth) Increasing

Financial Account Deficit

Capital Outflow

Lending Surplus savings to the Rest of the World

If Sn < I CA < 0  ∆NFA < 0

Balance of Trade Deficit EX<IM

Current Account Deficit

Net Foreign Debt Increasing

Financial Account Surplus

Capital Inflow

Borrowing savings from the Rest of the World

Topic 2

Intertemporal model of the current account

What is the Current account balance in the UK?

What has been the trend in interest rates?

Can we imply anything from interest rate differentials in the UK relative to the EURO zone - Does the UK have a comparative advantage in current or future consumption.

(Note: although the UK was part of the EU it retained its own currency – did not join the monetary union)

Considering the Intertemporal model_- What does the CA balance now imply about the CA balance in the future?

Intertemporal model

A country with positive initial net foreign wealth (a creditor country) can afford to run trade deficits “on average” in future; conversely a country with negative initial net wealth (a debtor country) is required to run trade surpluses “on average” in future.

Relative to a trading partner, does the UK have a comparative advantage in current or future consumption

Some countries will have a comparative advantage in future production of consumption goods.

A low relative price of future consumption, or a high real interest rate - Rc.

Their PPF is biased toward production of future goods

Others will have a comparative advantage in current production.

A low relative price of current consumption, or a low real interest rate - Rc.

Their PPF is biased toward production of current goods

It may be optimal for these countries to trade consumptions over time. The Home Country runs a current account deficit and accumulates external debt; vise versa the Foreign Country.

Consider the UK when reviewing the following? Applicable or not?

If a country has a preference for current over future consumption and/or has abundant productive investment opportunities it is likely to have a high closed economy real rate of interest and thereby run a Current Account deficit and a Financial Account surplus.

A Financial Account surplus means that the country is issuing future claims on itself which is effectively the giving up of future consumption claims.

If a country has a preference for future over current consumption and/or there is an absence of productive investment opportunities it is likely to have a low closed economy real rate of interest and run a Current Account surplus and a Financial Account deficit.

A Financial Account deficit means that the country is accumulating future claims on foreigners which results in an increase in future consumption claims.

Hence if two countries have different intertemporal consumption preferences and investment opportunities both can be made better off as a result of trading consumption claims over time.

Topic 3- theories of exchange rate determination

Has the value of the UK currency GBD has fallen since Brexit? (remember different quotation methods)

What theory of exchange rate determination might best explain exchange rate fluctuations and why? Consider UIP? What has happened to the price level in recent months,

What has happened to the market for assets?

What has happened in the market for UK treasury bills?

What has happened to nominal interest rates? Is the Dornbusch model explanatory in any way?

What are expectations of future exchange changes?

Exchange rate determination

The Exchange Rate in the Short Run

The Asset Market Model

Covered Interest Parity

Uncovered Interest Parity

Unbiased Expectations Theory

The Exchange Rate in the Long Run

Absolute and Relative Purchasing Power Parity

International Fisher Relationship

The Monetary Model

Sticky Price Model and Overshooting

Exchange rate determination theories

How Important might the asset market approach to short run exchange rate determination in the UK. What was the initial market response to Brexit

The purchasing power parity theory of exchange rates – Price differentials between the UK and trading nations

The monetary theory of the exchange rate. Has Money supply changed in the UK?

Explain why exchange rates may overshoot their long run level in the short run

Topic 3 – critically assess the theories of exchange rate determination

Exchange rate determination: what has happened to the GBP pre and post Brexit vote

http://www.exchangerates.org.uk/news/16193/gbp-eur-usd-exchange-rate-news-and-currency-forecast.html

http://www.express.co.uk/finance/city/658338/Brexit-EU-Exit-How-Affect-Pound-UK-Economy

Topic 4 – how might exchange rate changes impact on the trade balance and the current account

Likely outcomes if the domestic currency (GBP)depreciates?

Consider changes in the value of the domestic currency, what might we expect to happen to the trade balance?

Consider the elasticities / absorption approaches – have they any relevance?

Elasticities approach

Elasticities

Import and Export markets -

Would the UK be considered a large or small country in the import or export markets

Consider the changes in the trade balance for a change in the value of the domestic currency

Likelihood of 100% pass through?

The J – curve?

The Absorption approach

An increase in the exchange rate (A decrease in value of domestic currency)

If a reduction in the value of the domestic currency raises income and output relative to absorption, the trade balance will improve.

A reduction in the value of the domestic currency will increase income if net exports increase, and we are below full employment.

A reduction in the value of the domestic currency will have indirect (via change in Y) and direct effects on absorption.

An increase in the exchange rate (A decrease in value of domestic currency) Case 1. Below full employment

X – IM

Y0 Y1 Y

(X – IM)2

(Sn – I)1

(X – IM)1

Topic 5 – The RER

Consider changes in the nominal exchange rate – what impact does this have on the RER and the Consumption and production of tradeables and non tradeables.

Is there a policy lesson to considered here?

Changes in the RER and Competiveness of UK goods

An increase in RER will increase (decrease) CN (CT) and increase (reduce) QT (QN). An increase in RER switches spending away from tradeables to non-tradeables (as non-tradeables are now relatively inexpensive) and increases profits in the traded goods sector relative to the non-traded goods sector.

An increase in absorption will increase CN and CT.

The UK economy – which quadrant?

BoT D

inf

BoT S

inf

BoT S

Unem

BoT D Unem

RER0

Policy assignment

How to restore – Internal / External balance

Expenditure changing?

Expenditure Switching ?

Policy tools should be assigned responsibility for those policy variables on which they have a relatively greater effect. Expenditure Changing policy (A) should be assigned to the more inelastic curve and Expenditure Switching policy (RER) to the more elastic curve.

Topic 6 – IS-LM-BP –

Flexible Exchange rates

High capital mobility

Consider fiscal policy – under static and regressive expectations

Consider monetary policy. Britain has high capital mobility and its central bank has recently lowered interest rates to try to stimulate the economy

What policy lever has been put into place predominantly post the Brexit vote

Use the model to consider rationale for policy enacted

Effects on trading partners and regions

Three key transmission mechanisms whereby macroeconomic events in one country can spill over to other countries.

The income-expenditure effect resulting from a country’s trade account.

Monetary impulses in one country may be transmitted internationally via their effect on interest rates and the financial account of the balance of payments.

Relative price adjustments will spill over from one country to another through movements in the exchange rate.

Flexible exchange rates – Monetary Policy

IS*1

LM0

LM1

IS0

IS1

LM*

IS*0

IS*2

i*d

i*f

YA YB YC

Y*F Y*D Y*E

Flexible / Floating exchange rates - Fiscal policy

LM*

IS*2

LM0

IS0

IS1

IS*1

IS*0

i*d

i*f

YA YC YB

Y*D

IS2

Topics 7 & 8

Are the 1st or 2nd generation models of currency crisis applicable to the Brexit model

Is the EU an optimal currency area

What made those in the UK feel it was in their best interests to leave the EU

Some more reading !

The Australian - Brexit best for Britain ?

The financial times: Brexit in seven charts - the economic impact

Understanding and addressing the task

Contextualizing and applying c ourse theory to a real world economic event – in this case Brexit.

Your answer should reflect some of the following topics:-

 Topic 1: Does Britain run a Current account deficit or surplus. Is this driven by the trade balance . Is Britain a net lender or a net borrower to the rest of the world

 Topic 2: Consider the Metzler diagram – what might happen to Investment and saving schedules – what does this say about whether Britain has a comparative advantage in

current consumption or future consumption

 Topic 3: Exchange rate determination: Has the value of the UK currency GBD has fallen since Brexit – what theory of exchange rate determination might best explain exchange

rate fluctuations and why? Consider UIP? What has happened to the price level in recent months, What has happened to nominal interest rates ? Is the Dornbusch model

explanatory in any way? What are expectations of future changes?

 Topic 4: Consider changes in the value of the domestic currency, what might we expect to happen to the trade balance? Consider the elasticities / absorption approaches –

have they any relevance?

 Topic 5;: Consider changes in the nominal exchange rate – what impact does this have on the RER and the Consumption and production of tradeables and non tradeables. Is

there a policy lesson to consider ed here?

 Topic 6: Britain has high capital mobility and its central bank has recently lowered interest rates to try to stimulate the e conomy – What would a simple ISLMBP model suggest

might be the effect on the GDP

 Topics 7 & 8: Are the 1

or 2

generation models of currency crisis applicable to the Brexit model

 Is the EU an optimal currency area

Structure

- Introduction – background - What has happened

- Implications for the domestic UK economy

- Implications for a trade partner

- What kinds of policy might you recomm end to deal with the implications you identified and why

- conclusion

Should be concise, due to exam time constraints – (what can you reasonably write within 25 mins – note you may choose to cover two or three topics or you may be more general

across all topics)

Understanding and addressing the task

Contextualizing and applying course theory to a real world economic event – in this case The Asian Financial Crisis

Reflecting the following topics or any others that might apply:-

 Topic 1: Current account balances pre and post the crisis

 Topic 3: Value of the domestic currency relative to the USD

 Topic 5: Price of Tradeables relative to non Tradeables

 Topic 7: Choice of exchange rate regimes in Asian pre and post the crisis

 Topic 6: Monetary policy and exchange rate regimes

 Topic 6: Fiscal policy and exchange rate regimes

 Topic 8: Do either the simple crisis model or the second generation model offer insights into what happened



Structure

- Introduction – background

- What happened to key economic indicators?

- Implications on Y or GDP of the cho sen economy or region

- Implications for trade partners or the Global economy

- What kinds of policy might you recommend to deal with the implications you identified and why

- Conclusion

Should be concise, due to exam time constr aints – (what can you reasonably write within 25 mins)

RER