Section7 - Econ 100B Section 101 102 Summer 2009 UC Berkeley Phakawa On Jeasakul Practice Problems 1 Asian Financial Crisis Suppose that prior to

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Econ 100B Section 101 & 102 Summer 2009 – UC Berkeley Phakawa On Jeasakul July 23, 2009 Practice Problems 1. Asian Financial Crisis . Suppose that prior to the crisis, the Thai economy is overheating (i.e., output is above full-employment output). We will look at some aspects of economic development and policy consequence using a closed-economy IS/LM model; of course, it is more appropriate to use an open-economy version. Consider what happens after the Bank of Thailand let the Thai baht float on July 2, 1997. a. The Thai exchange rate depreciated substantially. Firms that had borrowed money from abroad experienced a sharp increase in debt burden, thus stop undertaking new investment. b. Consumers also became worried about the national economic situation, and decided to consumer less for a given level of disposable income. c. The stock market also collapsed as foreign investors did not want to invest in Thailand. It is sufficient to consider the wealth effect only through the goods market. d. The banking crisis also set off because a large fraction of loans became non-performing. As problems in the financial system emerged, non-money assets became much more risky and illiquid. e. Lastly, household expected that public saving would decline substantially because the government needed to bail out failed financial institutions. Because the country did not have sufficient foreign reserves, the Thai government decided to borrow money from the IMF. The IMF’s loan came with conditions. The country must implement the following macroeconomic policies: f. The government must cut government spending so that the fiscal budget turned into a surplus. g. Monetary policy must also be tight in order to control inflation and to stabilize the exchange rate. Later on, the IMF admitted that its policy recommendation was inappropriate. Therefore, the IMF immediately allowed the government to have a fiscal deficit, while remaining reluctant with a change in monetary policy. h. The government thus increased the government spending and cut taxes. i. After panic subsided and the exchange rate became more stable, the central bank decided to use monetary policy to help the economy attain the full-employment level. 2. Liquidity Trap. As you may know the nominal interest cannot be negative, the question will ask you to consider what may happen to the economy when the nominal interest rate remains at zero. First, let’s derive the LM curve (recall that expected inflation is given). Second, what should happen to the economy if the central bank increases the supply of money?
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3. Monetary Policy. The central bank may target the money supply or the (real) interest rate. Consider what happens to the economy when there is an expenditure-driven shock and a money
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This note was uploaded on 09/08/2009 for the course ECON 100B taught by Professor Wood during the Summer '08 term at University of California, Berkeley.

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Section7 - Econ 100B Section 101 102 Summer 2009 UC Berkeley Phakawa On Jeasakul Practice Problems 1 Asian Financial Crisis Suppose that prior to

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