University of Toronto
Macroeconomics, Theory and policy
Masoud Anjomshoa
Economics Department
Solution set
#7
Disclaimer: These solutions are just guidelines for you, and may NOT
include a complete solution for the
questions and problems in your homework, as you must present in your assignments and/or exams.
In your
solutions you must show your work, and demonstrate your line of thinking clearly.
Please, always check my
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Blanchard, Chapter 6, Q# 1.
a)- True
b)- False.
If Singapore has balanced current account, and also export/GDP greater that one, then both import/
GDP is also greater than one.
c)- False.
Japan has a big economy, which despite huge import/export sectors, they are still small relatively.
d)- False.
The difference in equal to expected depreciation rate.
If there is no expectation of depreciation or
appreciation, then interest rates must be equal.
e)- True, if it is assumed that Canadian dollar is the domestic currency and American dollar the foreign one.
f)-
True, if it is assumed that Canada is the domestic country and the US is the foreign one.
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Blanchard, Chapter 6, Q# 4.
a)-
i
canada
= [(10000/9615.38) – 1]= 4%,
and
i
US
= [(13333/12698.10) – 1]= 5%
b)-
i
canada
= i
US
+ Expected Depreciation Rate
Expected Depreciation Rate = 4%
– 5%= -1%
So we expect an appreciation of Canadian exchange rate:
$1
US
= 0.95 * (1-0.01) = $0.9405 CAN
c)- In this case, it is better to buy American bonds, because rate of return would be higher than 5%.
d)-
If you substitute the expected exchange rate, E
e
, by the actual exchange rate, E
a
, in uncovered interest parity
condition, then instead of the expected rate of return, you get the realized rate of return.
So given the actual
exchange rate in the next year, which is 0.9, and the US interest rate, 5% from above:
The realized rate of return=
i
US
+ (E
a
–E)/E
=0.05 +[(0.9-0.95)/0.95)] = 0.05 – 0.05263 =0.00263= –0.263%
e)- Uncovered interest parity applies only on “Expected Rates”.
So it implies that expected rate of return to
foreign and domestic assets are equal.
But the actual rates can be different depending on how different the
expected and actual rates of return turn out to be.
The later depends on how expected depreciation rate come
true or not.
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