Microsoft Word - Exam2_160B_S21.doc
TAKE HOME EXAMS
COVER PAGE
SPRING 2021
* Write your answers directly on this exam (on printed copy or edit in PDF)
* Submit completed exam by uploading to Canvas>Gradescope (scanned or edited PDF)
* NOTE: Submit all pages when you upload, including cover pages, and any you left blank,
ecause Gradscope expects the submission pages to match the blank exam
BEFORE STARTING THE EXAM YOU MUST READ AND SIGN THIS
MANDATORY STUDENT STATEMENT
As a student at UC Davis, I hold myself to a high standard of integrity, and by
signing/accepting the statement below I reaffirm my pledge to act ethically by
honoring the UC Davis Code of Academic Conduct. I will also encourage other
students to avoid academic misconduct.
I acknowledge that the work I submit is my individual effort. I did not consult with
or receive any help from any person or other source. I also did not provide help
to others. I may work with others only if the instructor gave specific instructions,
and only to the extent allowed by the instructor.
I understand that suspected misconduct on this assignment/exam will be
eported to the Office of Student Support and Judicial Affairs and, if established,
will result in disciplinary sanctions up through Dismissal from the University and a
grade penalty up to a grade of “F” for the course.
I understand that if I fail to acknowledge or sign this statement, an instructor
may not grade this work and may assign a grade of “0” of “F”.
Signature:
___________________________________________________________
1
UC Davis
ECN 160B: International Macroeconomics
Spring 2021
Midterm Exam 2
Start: May 17, 2021, 12 noon, California time
End: May 19, 2021, 12 noon, California time
Professor Alan M. Taylor
Please:
Enter your name and ID# below
DO NOT OPEN the exam until you are given instructions to do so
This exam contains 8 pages.
There are 4 questions worth 10 points each.
This is a 1 hour and 20 minute exam.
Spring 2021: FOR THIS REMOTE EXAM: You have 48 hours to submit and the exam is open-book.
You must show your work on all questions to receive credit.
The UC Davis Code of Academic Conduct applies
Name: ______________________________________________________________
ID #: ______________________________________________________________
Question 1 (10 points)
Question 2 (10 points)
Question 3 (10 points)
Question 4 (10 points)
Total (40 points)
2
1. Miscellaneous Short Questions [1 point each]
a. The sum of consumption, investment, government consumption, and the
trade balance is called
_______________________________________________________________________________________
. The cu
ent account is equal to the sum of three balance of payments items
________________________ plus ________________________ plus ________________________
c. This year a country’s trade balance is +$186 billion, its net factor income
from a
oad is +$27 billion, its net unilateral transfers are –$8 billion, and its
capital account is –$3 billion. What is the country’s financial account? If the
country has net capital gains (valuation effects) on its external wealth of
+$42 billion, what is the change in its level external wealth W?
Financial Account FA = _______________________________________
Change in external wealth = _______________________________________
d. A country has zero external wealth initially. The world interest rate is r*
and the country’s trade balance is TBn in period n = 0, 1, 2, 3,…. Write down
an expression for the country’s long-run budget constraint (LRBC):
_______________________________________________________________________________________
e. The world real interest rate is r* = 2%. The country of Riskistan can bo
ow
at this rate and invest 1000 units of real output in a project where the extra
payoff in all future periods is 50 (we assume no depreciation). What is MPK?
Should they undertake the investment project? Explain.
MPK = ____________________________ Should they invest? ____________
Explanation:
€
ΔW
3
f. In the last question, suppose investors learn of political instability in
Riskistan and demand a risk premium of +5%. Now Riskistan can only
o
ow at a real interest rate of r* = 7%. Should they still do the project?
Should they invest? ____________
Explanation:
g. There are two states of the world. In state 1, Home has output and income of
60, and Foreign has 40. In state 2, Home has output and income of 40 and
Foreign has 60. There is no net international bo
owing or lending. If all
income is capital income, what is the best risk-sharing outcome possible?
State 1 consumption/income levels: Home _______ Foreign _______
State 2 consumption/income levels: Home _______ Foreign _______
Portfolios: Home owns _______ % home and ______ % foreign capital
h. When a country’s real exchange rate depreciates then, all else equal, its trade
alance should
Circle one: Increase / Decrease
i. Under a floating exchange rate regime, after a temporary home monetary
expansion, in the short run, the home country’s (circle answer in each case):
Nominal interest rate is… Higher / Lower / Unchanged
Nominal exchange rate is… Depreciated / Appreciated / Unchanged
Level of output is… Higher / Lower / Unchanged
j. Under a fixed exchange rate regime, after a temporary home fiscal expansion,
in the short run, the home country’s (circle answer in each case):
Nominal interest rate is… Higher / Lower / Unchanged
Nominal exchange rate is… Depreciated / Appreciated / Unchanged
Level of output is… Higher / Lower / Unchanged
4
2. IS-LM-FX [10 points]
Use the combined (side-by-side) IS-LM-FX diagram to answer this question.
Clearly label the figures: axes, equili
ium points, levels of variables.
Explain the graphs
iefly in words.
Assume the home central bank responds by using monetary policy to
stabilize output Y, and assume that the exchange rate is floating
For each of the following situations, use the IS/LM/FX model to illustrate the
effects of the shock and policy response combined. For each case, state the effect of
the shock and policy response combined on the following variables (increase,
decrease, no change, or ambiguous): Y, i, E, C, I, TB.
a. Shock: The level of foreign income increases (Y* rises). [5]
IS-LM diagram FX market
Explanations and effects of the shock and policy response combined:
5
. Shock: The exchange rate is expected to depreciate (Ee rises). [5]
IS-LM diagram FX market
Explanations and effects of the shock and policy response combined:
6
3. War and the Cu
ent Account [10 points]
The country of Imperia likes to fight wars (sometimes) and smooth consumption. It
has a GDP of Q=$1 trillion ($1000 billion) every year. It is year 0 and Imperia has
zero external wealth W=0 initially (inherited from year –1). The world real interest
ate is 5%.
If there is no war (i.e., peace) Imperia consumes all GDP, and never invests, with
C=GNE=GDP in all future years, and I=G=0. However, Imperia starts a war in year 0.
Fighting a war costs G=$84 billion per year.
The Long Run Budget Constraint (LRBC) applies, as in Chapter 6. Assume there are no
capital gains or capital transfers, KG=KA=0, so the change in W each period is exactly
equal to CA. Assume all quantities are real dollars.
a. It is year 0. Let us assume that, at first, Imperians think the war will last only
1 year, so peace will resume in year 1. Under that assumption, how much will
they bo
ow in year 0 to finance the war? How much do they cut their
consumption? [2]
Bo
ow __________________________ Cut ________________________ (use $ billions)
[Hint: display expected paths of Q, C, G, TB, NFIA, CA, W to verify the answer.]
. Now treat the events in year 0 as given above in part a. Now it is year 1, and
now the Imperians find they can’t exit the war. They now update their beliefs
and now they think the war will last 1 more year, and peace will resume in
year 2. How much extra should they bo
ow at this point? How much more
do they cut consumption? [2]
Bo
ow __________________________ Cut ________________________ (use $ billions)
[Hint: display expected paths of Q, C, G, TB, NFIA, CA, W to verify the answer.]
7
c. The same thing happens in years 2, 3, and 4: each time, Imperians find they
can’t exit the war and then expect it to last one more year. How much more
do they bo
ow and how do they cut their consumption each time? [2]
Bo
ow __________________________ Cut ________________________ (use $ billions)
d. Now suppose Imperians had known the war would last 5 years (year 0 to 4)
from the very beginning in year 0. Would they have chosen this consumption
path? Why or why not? (Do not provide any calculations here.) [2]
e. It turns out that the rest of the world will not lend unlimited amounts to
Imperia. In fact Imperia’s debt limit is 80% of Imperian GDP or $800 billion.
How long a war can Imperia afford to fight using external finance to smooth
consumption when it proceeds as above [in parts a
c], extending the war
one year at a time? [2]
8
4. Balance of Payments [10 points]
The year is 2018. Debtland’s GDP is $650 billion. Debtland has a cu
ent account
deficit of $42 billion. Debtland’s capital account is in a $12 billion surplus. In
addition, Debtland factors located in foreign countries earn $17 billion. Debtland has
a trade deficit of $33 billion. Assume Debtland neither gives nor receives unilateral
transfers, and assume that there are no capital gains on external wealth.
a. What was the change in Debtland’s external wealth (W) during 2018? [2]
. Compute Debtland’s net factor income from a
oad (NFIA). [2]
c. How much income did foreign factors of production earn in Debtland (IMFS)?
[2]
d. Compute Debtland’s gross national expenditure (GNE), gross national income
(GNI), and gross national disposable income (GNDI). [2]
e. If Debtland’s external wealth was –$150 billion at the end of 2017, what was
it at the end of 2018. [2]