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EXAM II, ECON 457
SPRING 2017
March 23, 2017
Each multiple choice question is worth four points.
NAME
UID
1. There is a limit to a nation's ability to use international financial markets to supplement
domestic consumption or investment. Why?
A) Lenders like a diversified group of borrowers.
B) International lenders require collateral.
C) Communication is difficult because of language and differences in legal systems.
D) At some point, a nation will not be able to service the rising level of external
debt.
2. The United States has experienced a favorable situation in world financial markets.
What is it?
A) The United States has huge net external wealth and is able to control many foreign
corporations, banks, and governments as a result.
B) Even though the United States has huge net external debt, it has benefited
from a 1.5% gain in interest differential and an additional 2% capital gain on
its net debt/wealth.
C) Other nations deposit their funds in U.S. banks, making them available for U.S.
borrowers.
D) Politically the United States is very powerful, and most international financial
organizations want good relationships, making financial dealings more favorable to
the United States.
3. Low-income nations with poor credit ratings are often dependent on commodity sales as
a major portion of income. To insure against the effects of a fall in the prices of
commodities, the nation could:
A) borrow internationally.
B) save as a precaution and purchase sovereign wealth funds with that money.
C) ask for debt reduction and forgiveness.
D) enter into a cartel to boost the prices of commodities.
4.
5.
A)
B)
C)
D)
If a nation experiences an exchange rate appreciation, what happens to the value of its
external wealth?
A) It decreases.
B) It depends on the currency composition of its assets and liabilities.
C) It increases.
D) It depends on the size of its assets compared to the size of its liabilities.
If a nation's yearly trade balance exactly offsets the interest due on its net external wealth, what is
the effect on its net external wealth?
It remains the same.
It explodes.
It declines at first and then rises dramatically.
It rises gradually because of interest compounding.
Use the following to answer next two questions:
Table: Hypothetical Canadian National Income and Product Accounts Data
Category
Consumption (personal consumption expenditures)
Investment (gross private domestic investment)
Government consumption (government expenditures)
Exports
Imports
Foreign income payments to domestic factors
Domestic income payments to foreign factors
Net unilateral transfers
Billions of dollars
400
150
80
210
60
20
10
5
6. (Table: Hypothetical Canadian National Income and Product Accounts Data) The GNE is
_______.
A) $630
B) $550
C) $230
D) $120
7. (Table: Hypothetical Canadian National Income and Product Accounts Data) The trade balance
for the economy provided is ______.
A) –$60
B) –$150
C) $150
D) $270
Use the following to answer next question:
Table: Hypothetical Irish National Income and Product Accounts Data
Category
Consumption (personal consumption expenditures)
Investment (gross private domestic investment)
Government consumption (government expenditures)
Exports
Imports
Foreign income payments to domestic factors
Domestic income payments to foreign factors
Net unilateral transfers
Billions of dollars
1,200
700
200
500
600
100
400
–10
8. (Table: Hypothetical Irish National Income and Product Accounts Data) What is the current
account for Ireland?
A) $310
B) $290
C) –$290
D) –$410
9. If investment exceeds national savings, then the current account:
A) must be negative.
B) must be zero.
C) must be positive.
D) not enough information
10. If George purchases shoes from a Japanese firm for $100, and pays for them by borrowing $100
on his Japanese credit card, the two accounts that are affected are:
A) imports of goods with a minus (debit) and exports of goods with a plus (credit).
B) imports of goods with a minus (debit) and exports of financial assets with a plus
(credit).
C) exports of goods with a minus (debit) and imports of financial assets with a plus (credit).
D) exports of goods with a plus (credit) and imports of financial assets with a minus (debit).
11. A key assumption to ensure that domestic returns and foreign returns are in equilibrium
is:
A) there are perfectly flexible prices.
B) the quantity of money is fixed.
C) there are no capital controls preventing the movement of capital.
D) trade is not subject to any restrictions.
12. Asset exports occur when domestic entities:
A) save internationally by purchasing foreign assets.
B) borrow internationally by selling assets to foreigners.
C) increase savings and decrease spending both domestically and internationally.
D) decrease savings and increase spending on foreign goods.
13. If we add the current account balances for every nation, the overall balance will equal:
A) the size of world GDP.
B) spending minus savings.
C) zero.
D) the value added in the manufacturing sectors of each nation.
14. Assuming all transactions are recorded, if the United States has an overall deficit (–) in
its current account, what is the implication for the balances of the other accounts (capital
and financial)?
A) Added (FA + KA), they must be in surplus (+) by exactly the same amount.
B) Their difference (FA – KA) is equal to the deficit (–) in the current account.
C) Added (FA + KA), they will be in deficit by exactly the same amount.
D) Their difference (FA – KA) must be equal to zero.
15. If the US forgives $2 billion of debt owed by a foreign country, the Balance of
Payments account entry would show $2 billion as
A) A positive entry in the capital account (KA) and a negative entry in the financial
account (FA)
B) A negative entry into the capital account (KA) and a positive entry in the
financial account (FA)
C) A negative entry into the capital account (KA) and a positive entry in the current
account (CA)
D) A positive entry in the financial account (FA) and a negative entry in the current
account (CA)
16. While deriving the Long run budget constraint of a small open economy model, a key assumption is
made that
A) the economy must enter period 1 with zero net foreign assets and ends period 2 with
positive net foreign assets
B) the economy enters period 1 with zero foreign assets and ends period 2 with zero net
foreign assets
C) there is no restriction on initial wealth but the end of period 2 wealth must equal zero.
D) None of the above
17. The present value of an income flow of $121 two years from now equals $100
A) if the annual interest rate is 11%
B) if the annual interest rate is 5%
C) if the annual interest rate is 9%
D) none of the above
18. The WSJ report “Central banks ratchet up foreign currency reserves” argues that the recent rise in
foreign reserve accumulation has been due to
A) Chinese intervention in the foreign exchange market to manage its currency
B) Emerging markets’ central banks have accumulated these reserves for
precautionary/insurance purpose
C) Some small European central banks have intervened in foreign exchange markets from letting
their currencies appreciate
D) All three, A,B, and C above
E) Only B and C above
19. The NY Times article “Iceland,..,Finally lifts capital controls” informs that
A) capital controls have helped Iceland regain its economic health. Otherwise, it would have
suffered a much worse financial and economic crises
B) capital controls have been a deterrence for Iceland’s firms from attracting foreign investors
C) Both A) and B) above
D) Only A above
E) Only B above
19. What do the “official reserves” movements in the Net International Investment accounts stand for?
How do the movements in the US official reserves compare with that of reserves held by the foreign
nations? (You are not expected to remember the numbers. A relative size description will suffice) (4
points)
20. An open economy’s output is expected to be 100 units forever and it can borrow and lend
freely from the rest of the world at an interest rate 10%. Assume that the initial wealth is zero
and there are no unilateral transfers. There is no government spending, i.e., G=0 for all times.
Then , a sudden need for the government spending arises as it goes to war with its neighboring
country that requires 44 units in time period t = 0. Thereafter, no government spending is
anticipated, i.e., G = 0, t=1,2,3….The country’s output remains at 100 as before forever. If the
economy always chooses a smooth consumption, what will be the consumption level that it will
choose? What will be the trade balance in period 0? What will be the wealth level at the end of
period 0? What is the trade balance, NFIA, Current account, and wealth level at the end of period
1, 2, 3,…[12 points]
Answer: Consumption is calculated using
(1 + 1/0.1) C = PV(Q) – G = 100 + 100/0.1 – 44 = 1056.
Thus C = 96.
TB0 = 100 – 96 – 44 = -40.
NFIA0 = 0
CA0 = -40+0 = -40
W0 = 0-40 = -40
From period 1 onwards, TB = 4; NFIA = -4, CA = 0, and wealth W1 = -40. This repeats forever.
21. In each of the following cases what specific entries will occur in the balance of payments
accounts? (6 points)
a. A US citizen buys Japanese bonds worth $10000 by paying through her checking
account.
FA- Import of assets: -$10000
FA- Export of deposits: $10000
b. You decide to send $500 worth of food items to Sudan as donation.
CA: Export of goods $500
CA: Unilateral transfers (out) -$500
c. Starbucks sells its franchises in India worth $50 million.
KA: rights transfer +$50
FA: Import of Indian deposits -$50
22. Does a country with a positive Financial Account increase or decrease its external wealth?
What are the other balance-sheet factors that can aggravate/offset such changes in external
wealth? (4 points)
Answer: A positive entry means a net export of assets. The country’s external wealth decreases
as a result. Capital gains and exchange rate valuation effects may either offset the decrease in
wealth or further lower it.
23. Consider a small open economy that exists for two periods : date 0 and date 1. It enters date 0
with a negative external wealth (debt) of 100 units. Assume that the world interest rate is 5%.
The economy decides to pay off the due interest and a part of the outstanding debt by running a
trade surplus of 85 units. What amount of trade surplus or deficit this economy can run in period
2, i.e., on date 1, if its long run budget constraint is to hold? (6 points)
-(-105) = 85 + TB1/(1.05). Therefore TB1 = 21.