Tutorial 9 - Answers.pdf - ECON110 TUTORIAL 9 PART A...

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Unformatted text preview: ECON110 TUTORIAL 9 PART A: DEFICITS, DEBTS AND FISCAL POLICY PART B: INTERNATIONAL FINANCE LAST (FAMILY) NAME: FIRST NAME: STUDENT ID: PART A: DEFICITS, DEBTS AND FISCAL POLICY LEARNING OBJECTIVE 3: UNDERSTAND THE ROLES OF THE AUTOMATIC STABILISERS AND DISCRETIONARY POLICY ON GDP & UNEMPLOYMENT. ILLUSTRATE THIS ON THE AD-AS DIAGRAM. 1. Discuss the impact on size of the decrease in GDP during a recession, if the government were to tighten the eligibility and dramatically decrease the size of the unemployment benefit. (1 mark) The size of the decrease in GDP would be larger. 2. Choose the diagram which represents the economy with the more generous unemployment benefit. Assume all the other factors in the economy are the same. Explain your choice. (1 marks) The steeper the AD curve because the more generous unemployment benefits the less consumption decreases (for a given decrease in inflation) consequently the smaller decrease in GDP. 3. Explain the main difference between the automatic stabilisers and discretionary fiscal policy. (1 marks) The automatic stabilisers change automatically with the business cycle.Discretionary fiscal policy requires a deliberate change in policy;that is a deliberate decision on the part of the government. LEARNING OBJECTIVE 4: UNDERSTAND THE CYCLICAL AND STRUCTURAL COMPONENTS OF THE BUDGET. 4. Fill in the following table. (1.5 marks) (Minus ½ a mark for each incorrect answer Relationship Between Structural, Cyclical and Actual Budget If GDP = AND T-G = 0 Economic Situation GDP = Structural Budget T-G=0 T-G>0 T-G<0 Cyclical Budget T-G=0 T-G>0 T-G<0 T-G=0 Actual Budget T-G>0 T-G<0 GDP > (Boom) GDP < (Recession) LEARNING OBJECTIVE 5: RECOGNISE THAT THE GOVERNMENT DEBT IS THE ACCUMULATED BUDGET DEFICITS PLUS ANY INTEREST OWED and LEARNING OBJECTIVE 7: ASSESS THE IMPACT OF AUSTERITY PROGRAMS ON GDP, THE BUDGET & GOVERNMENT DEBT/GDP RATIO 5. Fill in the following table. (1.5 marks) (Minus ½ a mark for each incorrect answer). Relationship Between Structural, Cyclical and Actual Budget If GDP = AND T-G<0 Economic Situation GDP = GDP > (Boom) GDP < (Recession) Structural Budget T-G=0 T-G>0 T-G<0 Cyclical Budget T-G=0 T-G>0 T-G<0 T-G=0 Actual Budget T-G>0 T-G<0 6. Choose the diagram below that shows a government implementing an austerity program. (1 mark) 7. Discuss the impact on the Debt/GDP ratio. In your discussion consider the impact on the budget and the impact on GDP. (1 marks) GDP will decrease because of the cuts to G & the increases in T. The overall impact on the budget depends on the relative impact on the structural and cyclical budget. There would be an improvement in the structural deficit from the austerity package. There will be a cyclical deficit because of the decrease in GDP. For the debt to be paid down there will have to be a surplus on the overall budget. It is possible that the decrease in the GDP is greater than any decrease in the debt arising EVEN IF there is any surplus in the budget, hence the debt/GDP ratio may actually increase with an austerity program. PART B: INTERNATIONAL FINANCE LEARNING OBJECTIVE 1: UNDERSTAND THE DIFFERENT COMPONENTS (CURRENT & CAPITAL ACCOUNTS) OF THE BALANCE OF PAYMENTS & LEARNING OBJECTIVE 2: ASSESS THE COSTS AND BENEFITS OF CAPITAL INFLOWS AND OUTFLOWS. 1. Historically Australia has been a net recipient of overseas capital. Recently much of this capital has come from China. i) Discuss the general benefits of capital inflows on the Australian economy. (1 marks) The general benefits of increased investment, increased GDP and the increased employment. ii) Discuss the general costs of capital outflows on the Chinese economy. (1 marks) The general costs for China of capital outflows are decreased investment, decreased GDP and decreased employment. iii) Choose the diagram that illustrates the benefits of capital inflows on the Australian economy. Choose the diagram that illustrates the costs of capital outflows on the Chinese economy. (1 marks) Australia China iv) Outline the costs of foreign investment on the Australian economy. Refer specifically to the costs that show up on the current account. See the diagram below. (1 marks) Australian Current Account Balance 1990-2012 Borrowing overseas increases investment. However, there is a downside. 1. Profits have to be large enough to pay back the interest on borrowing. 2. If the investment is FDI then the profits are repatriated overseas. This is income not received by locals. Both these are recorded as a negative on the current account. LEARNING OBJECTIVE 4: UNDERSTAND THE FACTORS THAT DETERMINE FLEXIBLE EXCHANGE RATES. ILLUSTRATE THE IMPACT OF THESE FACTORS ON THE EXCHANGE RATE DIAGRAM 2. Most western countries after the GFC entered a deep recession. Central banks responded by dropping interest rates to zero. Switzerland and Australia with trusted financial sectors only experienced mild recessions. Consequently, Switzerland and Australia had higher interest rates than other countries with politically stable governments and societies. Both Switzerland and Australia experienced large capital inflows. i) There were many other countries at the time with higher interest rates than Switzerland and Australia. Explain why investors would prefer to purchase financial assets in Switzerland and Australia. (1 marks) The decision to invest in interest bearing financial assets is based on a combination of the interest rate and the risk of the asset. There were many countries that had a higher interest rate than Switzerland or Australia at the time, but once the risk is taken into account the interest bearing assets, often government bonds offered the highest returns. The risks in Australia and Switzerland are low as their financial systems are safe and political systems stable. ii) Explain the impact on the exchange rate arising from the capital inflows into Australia or Switzerland. ( 2 marks) The capital inflows will mean that demand for the local currency will increase (and the supply of the local currency will decrease). Participants in the foreign exchange market need to purchase the local currency to buy say AUD denominated financial assets. The foreign exchange market for Swiss francs will behave in a similar manner. iii) Choose the diagram that illustrates the impact on the Australian dollar or Swizz Franc from the capital inflows. (1 marks) LEARNING OBJECTIVE 5: UNDERSTAND HOW FIXED EXCHANGE RATE SYSTEMS DIFFER FROM FLEXIBLE EXCHANGE RATE SYSTEMS. 3. The Swiss central bank intervened in the foreign exchange market to counteract the impact of capital inflows on the exchange rate.1 i) Explain the reasons for the decisions taken by the Swiss central bank. (1 marks) The Swiss central bank wants to limit the appreciation of the Swiss Franc to limit the increase in the price of exports (& limit the decrease in the price imports), prevent the decrease in net exports & consequently limit the decrease in GDP. 1 This is a continuation of the previous question except we are now looking at the central bank intervention. ii) Describe the actions taken by the Swiss central bank. (2 marks) To limit the appreciation in the Swiss Franc the central bank has to sell Swiss francs & purchase foreign currency. iii) Choose the diagram that illustrates the actions taken by the Swiss central bank (1 marks) ...
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