Download Assignment 3

Instructor: Yuan Liu
ECON160B,SSII 2013
Internationl Macroeconomics
Assignment 3
Due Sep 9th in class
1. Suppose that Mexico commits to fixing its exchange rate against the US dollar. Explain
the impact on the foreign reserve hodings of Mexican central bank if this fixed exchange
rate (peso/$) turns out to be lower than the exchange rate that would be obtained had
the exchange rate been allowed to float freely. What implications does this have for
the Mexican money supply and the Mexican central bank’s holdings of foreign reserves
(dollar assets)?
Answer: The only way to keep the exchange rate (peso/$) fixed at a lower rate than
the market would bear on its own would be for the Mexican central bank to purchase
pesos to keep its value high. This purchase of pesos lowers the amount of pesos in
circulation, thereby reducing the money supply. The way they do this is by selling an
equal value of their dollar denominated asset holdings.
2. Suppose that the foreign interest rate falls under a regime of fixed exchange rates
(where the central bank intervenes in the foreign exchange market to defend the official
exchange rate level). Use the FOREX market diagram to show the effects of this change
on domestic interest rates and the domestic nominal money supply in the short run.
Answer: The initial effect is for the foreign return curve to shift down. On its own this
would lead to a drop in the exchange rate from (an appreciation in the value of the
domestic currency). However, the domestic central bank is committed to maintain the
exchange rate unchanged. Thus domestic interest rate must also fall, implying that
the domestic money supply must increase.
3. Show how each of the following would affect the U.S. BOP. Include a description of
the debit and credit items, and in each case say which specific account is affected (e.g.,
imports of goods and services, IM ; exports of assets, EXA ; and so on).
(a) A California computer manufacturer purchases a $50 hard disk from a Malaysian
company, paying the funds from a bank account in Malaysia.
(b) A U.S. tourist to Japan sells his iPod to a local resident for yen worth $100.
(c) The U.S. central bank sells $500 million of its holdings of U.S.Treasury bonds to
a British financial firm and purchases pound sterling foreign reserves.
(d) A foreign owner of Apple shares receives $10,000 in dividend payments, which are
paid into a NewYork bank.
(e) The central bank of China purchases $1 million of export earnings from a firm
that has sold $1 million of toys to the United States, and the central bank holds
these dollars as reserves.
(f) The U.S. government forgives a $50 million debt owed by a developing country.
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Solutions
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Chapter 5
National and International Accounts
3. Show how each of the following would affect the U.S. BOP. Include a description of
the debit and credit items, and in each case say which specific account is affected (e.g.,
imports of goods and services, IM; exports of assets, EXA; and so on).
a. A California computer manufacturer purchases a $50 hard disk from a Malaysian
company, paying the funds from a bank account in Malaysia.
Answer:
Description
BOP Account
Account (detail)
Credit/Debit
Hard disk imported from Malaysia
Decrease in Malaysian deposits owned by U.S. firm
CA (↓)
FA (↑)
!IM (↑), TB (↓)
!IMFA (↓)
–$50
"$50
b. A U.S. tourist to Japan sells his iPod to a local resident for yen worth $100.
Answer:
Description
BOP Account
Account (detail)
Credit/Debit
iPod exported to Japan
Increase in Japanese currency owned by U.S. tourist
CA (↑)
FA (↓)
"EX (↑), TB (↑)
!IMFA (↑)
"$100
!$100
c. The U.S. central bank sells $500 million of its holdings of U.S. Treasury bonds to
a British financial firm and purchases pound sterling foreign reserves.
Answer:
Description
BOP Account
Account (detail)
Credit/Debit
U.S. bonds sold to British firm
Pound-sterling reserves imported from Britain
FA (↑)
FA (↓)
"EX (↑)
!IM (↑)
"$500 mil.
!$500 mil.
H
A
F
A
d. A foreign owner of Apple shares receives $10,000 in dividend payments, which
are paid into a New York bank.
Answer:
Description
BOP Account
Account (detail)
Credit/Debit
Import of factor service (ownership) from ROW
New York bank deposits paid to ROW
CA (↓)
FA (↑)
!IMFS (↑), NFIA (↓)
"EXHA (↑)
!$10,000
"$10,000
e.
The central bank of China purchases $1 million of export earnings from a firm
that has sold $1 million of toys to the United States, and the central bank holds
these dollars as reserves.
Answer:
Description
BOP Account
Account (detail)
Credit/Debit
Import of toys from China
China central bank buys U.S. dollars
CA (↓)
FA (↑)
!IM (↑), TB (↓)
"EXHA (↑)
!$1 mil.
"$1 mil.
f.
Solutions
■
Chapter 5
National and International Accounts
The U.S. government forgives a $50 million debt owed by a developing country.
Answer:
Description
BOP Account
Account (detail)
Credit/Debit
Debt forgiveness (gift)
Decrease in external assets owned by U.S. entities
KA (↓)
FA (↑)
#KAOUT (↑)
#IMFA (↓)
#$50 mil.
"$50 mil.
4. In 2010 the country of Ikonomia has a current account deficit of $1 billion and a
nonreserve financial account surplus of $750 million. Ikonomia’s capital account is in
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a $100 million surplus. In addition, Ikonomian factors located in foreign countries
earn $700 million. Ikonomia has a trade deficit of $800 million. Assume Ikonomia
neither gives nor receives unilateral transfers. Ikonomia’s GDP is $9 billion.
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4. In 2010 the country of Ikonomia has a current account deficit of $1 billion. Ikonomias
capital account is in a $100 million surplus. In addition, Ikonomian factors located
in foreign countries earn $700 million. Ikonomia has a trade deficit of $800 million.
Assume Ikonomia neither gives nor receives unilateral transfers. Ikonomias GDP is $9
billion.
(a) What happened to Ikonomia’s external wealth during 2010? Did it acquire or lose
foreign assets during the year?
BOP = CA + F A + KA = 0
−1000 + F A + 100 = 0
F A = 900
The financial account records financial flows into and out of the country. In this
case, the FA surplus indicates that on net, foreigners purchased more Ikonomian
assets (FAL) than Ikonomians purchased foreign assets. Therefore, the external
wealth of Ikonomia declined by $900 million.
(b) How much income did foreign factors of production earn in Ikonomia during 2010?
CA = T B + N F IA + N U T = −1000
−800 + N F IA + 0 = −1000
N F IA = −200
N F IA = EXF S − IMF S = 700 − IMF S = −200
IMF S = 900
The current account can be split into three components: the trade balance (final
goods and services), net factor income from abroad (payments to/from factor services) and net unilateral transfers).In the question, we are given the trade balance
(-$800 million) and the current account (-$1000 million). Net factor income from
abroad is -$200 million. This implies that foreign factors of production located in
Ikonomia earned more than Ikonomian factors abroad. We know that Ikonomianfactors abroad earned $700 million. Foreign factors located in Ikonomia earned
$900 million.
(c) Compute Ikonomia’s gross national expenditure (GNE), gross national income
(GNI), and gross national disposable income (GNDI).
GDP = GN E + T B
9000 = GN E − 800
GN E = 9800
GN I = GDP + N F IA = 9000 − 200 = 8800
GN DP = GN I + N U T = 8800
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