final2006 - Econ 434 Fall 2006 Final Exam Instructions Read...

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Econ 434 Fall 2006 Final Exam Instructions Read the entire exam over carefully before beginning. The value of each question is given. Allocate your time e ciently given the price schedule that is imposed. Graphs and diagrams can be very helpful, use whenever possible and label clearly. There are no trick questions. 1. (24%) Consider a small open economy with a f xed exchange rate and open capital markets (high degree of capital mobility). The economy is in both internal and external balance. Draw a diagram showing the initial situation (in i e space). (a) Provide a brief explanation of the slopes of the internal and external balance conditions. Whydotheyhavethes lopestheydo? (b) Suppose that, all of a sudden, foreign investors become scared about this country. The economy is no longer in external balance. If the economy does not su f er from currency mismatch show that exchange rate and interest rate policies can be used (in some com- bination) to restore external balance and maintain internal balance. What policies are changed and in what direction? (c) Suppose that the country su f ers from currency mismatch. Why might the normal (con- ventional) assignment of policies to deal with the loss of external balance be problematic? Explain. Why does this di f er from what happens in part (b)? Explain. (d) Why does currency mismatch make the response to a negative shock problematic for an economy? Explain. 2. (36%) True, False, Uncertain, and Explain. Provide concise answers and explanations, and cite the relevant theories, when applicable. (a) If the price of oil were to temporarily fall to $15 a barrel, we should expect the U.S. and other oil dependent countries to run a smaller current account de f cit. (b) According to the World Bank, GDP per capita in 2002 was close to $1,000 in China and $36,000 in the U.S. [This is a fact; do not discuss]. This implies that the typical U.S. person has about 36 times the purchasing power of a typical Chinese person. (c) Under the Bretton Wood system, the country at the center (the U.S.) can set its monetary policy at will. Other countries will have to adjust their monetary conditions. (d) Under a f xed exchange rate regime, a country can generally attain internal and external balance using only f scal policy. (e) Bubbles in asset markets can only occur if investors are irrational. (f) The interwar gold standard failed because the price of gold was too high.
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3. (20%) The US Treasury Secretary was just in China trying to persuade Chinese policymakers to let the value of the yuan be determined by the market. (a) Why would the US want China to adopt a more f exible exchange rate policy? (b) Why does China seemingly prefer its F xed rate of exchange to the dollar? What would happen to the yuan if China allowed it to f oat? (c) Under these circumstances, what do you think speculators are thinking? Is capital
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This note was uploaded on 01/11/2012 for the course ECONOMICS 434 taught by Professor Staff during the Fall '11 term at Pennsylvania State University, University Park.

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final2006 - Econ 434 Fall 2006 Final Exam Instructions Read...

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