Economics 340 International Economics Prof. Alan Deardorff Second Midterm Exam. Form (KEY) 0. March 27, 2017

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1 Page 1 of 14 (15) Economics 340 International Economics Prof. Second Midterm Exam Form (KEY) 0 March 27, 2017 NAME: Student ID No.: INSTRUCTIONS: READ CAREFULLY!!! 1. Please do not open the exam until you are told to do so. 2. PLACE YOUR NAME AND STUDENT ID NO. (THE EIGHT DIGIT NUMBER FROM YOUR M-CARD) ON THE EXAM AND ON THE SCANTRON SHEET. 3. Find the FORM NUMBER above and enter it where it asks for KEY on the scantron sheet. Be sure to fill in the bubbles. 4. This exam has 100 points and you have approximately 80 minutes to complete it. Check that you have all 14 pages of the exam, including this cover sheet. 5. Part 1 consists of 25 multiple choice questions worth 2 points each. Answers to these should be marked on the scantron sheet using a #2 pencil. There are no penalties for guessing. 6. Part 2 consists of short-answer questions for which you must provide written answers on these sheets. Point values for questions in Part 2 are indicated in parentheses. Part 2 has 48 points total. 7. That leaves 2 points unaccounted for. You will get these if (and only if) you put your name and ID number on both this exam booklet and the scantron sheet, and if you enter the form number (see above) on the scantron. 8. Good luck!

2 Page 2 of 14 (15) FORM 0 Economics 340 Second Midterm Exam Part 1: Multiple Choice (2 points each) Select the best answer of those given. Answers to this part should be marked on the scantron sheet using a #2 pencil. There is only one correct answer per question, and there is no penalty for guessing. 1. Foreign direct investment does not necessarily involve a net capital flow from one country to another because a. Acquisition of assets abroad can also be financed by borrowing in the host country. b. Investors may simply reinvest their earnings from their home-country operations. c. FDI need not include ownership of financial assets. d. FDI need not include ownership of real assets. e. Credits and debits in the balance of payments must be equal. a 2. Which of the following is a significant source of FDI, but is only a negligible host of FDI? a. Europe b. Japan c. Latin America d. Other Asia e. United States b

3 Page 3 of 14 (15) 3. Tariff Jumping occurs when a. A firm that otherwise would have exported to a country invests there instead, in order to avoid paying the country s tariff. b. A country raises a tariff against a foreign exporter who sells to it below cost. c. Countries raise (and lower) their tariffs in an effort to stabilize the price of a product on the domestic market. d. A firm buys inputs from domestic firms rather than importing them from abroad subject to a tariff. e. A government levies a second tariff, adding to the price of a good that has already been increased by another tariff. a 4. Which of the following is included in the current account? a. Interest payments b. Gifts c. Imports of services d. All of the above e. None of the above d 5. The assigned reading by Griswold points out that the US economy has usually when the US trade deficit was growing. The reason for this is that a trade deficit is growing income. a. Expanded; a cause of. b. Contracted; a hindrance to. c. Expanded; a result of. d. Contracted; reduced by. e. Been stable; irrelevant to. c

4 Page 4 of 14 (15) 6. Which of the following would not be included as contributing negatively to the U.S. balance of trade on goods and services? a. Purchase of a case of French wine by a member of the Arizona Highway Patrol. b. Purchase of shares of stock in an Egyptian corporation by a retired school teacher in Flint, Michigan. c. Sale of an insurance policy by the British Firm, Lloyds of London, to the city council of Lubbock, Texas. d. The hiring of a Canadian trucking company by a U.S. firm to transport horseradish into Canada. e. Sale of 1.4 tons of ripe tomatoes by a Mexican farmer to members of a fraternity at the University of Michigan. b 7. Which of the following would have an incentive to buy euros on the 30-day forward market? a. A speculator who expects the euro to appreciate substantially during the next month. b. A speculator who expects the euro to depreciate substantially during the next month. c. An American exporter who will be paid in euros 30 days from now. d. An American exporter who will be paid in dollars 30 days from now. e. A French importer who will make a payment in dollars 30 days from now. a 8. The Purchasing Power Parity Theory a. Says that if a country s price level rises, so must the value of its currency. b. Holds, by definition, at all times. c. Is useful for forecasting how exchange rates will change in the coming weeks and months. d. Says that the real exchange rate should remain constant over time. e. Is of little use, since exchange rates depart from parity ever further every decade. d

5 Page 5 of 14 (15) 9. According to the Asset Theory of the Exchange Rate, a country s exchange rate a. Must already be whatever people think it is about to be. b. Causes the prices of its government bonds to be equal to the prices of foreign government bonds of the same maturity. c. Is set by intervention of the Central Bank in order to maximize its return on assets. d. Equals the reciprocal of its trading partner s exchange rate. e. Depends primarily on interest rates at home and abroad. a 10. Based on the supply and demand for foreign exchange, which of the following should cause the Thai currency, the baht, to appreciate? a. Thais develop a taste for French wine. b. Thai consumers reduce their saving, causing interest rates in Thailand to increase. c. Scandal in Bangkok reduces the willingness of foreign aid agencies to give money to Thailand. d. Major exporters from Thailand relocate to produce in China. e. Thailand begins enforcing intellectual property rights, forcing Thai companies to pay licensing fees to foreign owners of patents. b 11. In order to peg its currency at an overvalued rate and avoid any resulting change in its money supply, a country s central bank should a. Buy foreign currency. b. Sell domestic currency. c. Buy bonds. d. All of the above. e. None of the above. c

6 Page 6 of 14 (15) 12. In the context of the exchange market, leaning against the wind refers to a. Trying to alter the value of the currency of another, larger, country. b. Speculation based on the expectation that a country s currency will appreciate. c. Speculation based on the expectation that a country s currency will depreciate. d. Intervention intended to slow the change of the exchange rate over time. e. The attempt to prevent a currency from depreciating when the country s rate of inflation exceeds that of its trading partners. d 13. Which of the following was not true of the Bretton Woods system of exchange rates? a. The official value of the U.S. dollar was fixed to gold. b. The IMF prohibited all countries, except the United States, from devaluing their currencies. c. Currencies other than the U.S. dollar were pegged to the dollar. d. Central banks other than the Fed used U.S. dollars as reserves. e. Persistent U.S. deficits led to an accumulation of dollars outside the United States. b 14. Under a floating exchange rate, an increase in the income tax would be expected to cause the currency to, because it leads to. a. Depreciate; a fall in the interest rate. b. Depreciate; rise in imports. c. Appreciate; a fall in the interest rate. d. Appreciate; a rise in exports. e. Appreciate; a capital inflow. a 15. Since 2014, the euro has fallen relative to the US dollar by about 20%. As a result of the effect of this change on relative prices of goods, we would expect a. US exports to rise. b. Eurozone imports to rise. c. The US economy to expand in the long run. d. The Eurozone economy to expand in the short run. e. All of the above.

7 Page 7 of 14 (15) d 16. Suppose that aggregate domestic investment in the United States falls because of a worsening of business expectations. This would be expected to cause a decline in aggregate income in Canada in part because a. The US interest rate will rise. b. The US dollar will appreciate relative to the Canadian dollar. c. Canadian Aggregate Demand will rise. d. Canadian exports to the US will rise. e. US imports from Canada will fall. e 17. Which of the following currency arrangements is currently used by the largest number of countries (based on data from 2016 reported in lecture)? a. No separate legal tender b. Hard pegged exchange rate c. Managed floating d. Crawling peg e. Independently floating exchange rate e 18. An advantage of a floating exchange rate is that a. The exchange rate seldom changes. b. If a country s costs rise due to inflation, the exchange rate provides across-theboard adjustment to restore competitiveness. c. It puts monetary policy in the hands of central bankers in foreign countries, who may be more competent. d. Exchange-rate appreciation increases aggregate demand and thereby stimulates the domestic economy. e. It permits central bankers to sterilize the effects of their intervention. b 19. On what do Nobel Prize winners Friedman and Mundell agree? a. That floating exchange rates are bad b. That fixed exchange rates are bad c. That pegged exchange rates are bad d. That pegged exchange rates are good e. That fixed and floating exchange rates are equally good

8 Page 8 of 14 (15) c 20. The snake in the tunnel refers to a. How a prominent exchange-rate speculator was described by the Prime Minister of Malaysia after a currency crisis. b. The arrangement in which European currencies were pegged within a wide band to the dollar and also within a narrow band to each other. c. One of the symbols depicted on euro notes, as an alternative to showing national landmarks and statesmen from individual countries. d. A derogatory term for a crawling pegged exchange rate. e. The supply and demand diagram used to analyze the effects of non-monetary expansion on the exchange rate. b 21. Which of the following was not one of the Maastricht Convergence Criteria? a. Current-account deficit less than 10% of foreign exchange reserves. b. Government budget deficit less than three percent of GDP. c. Long-term interest rates less than 2% above the average of lowest three Eurozone interest rates. d. Government debt less than 60% of GDP. e. Inflation rate less than 1.5% above the average of the lowest three Eurozone inflation rates. a 22. When it came into existence on Jan 1, 1999, the euro was worth $1.18 because a. Europeans sought purchasing power parity with the U.S. dollar. b. This happened to be the value of the Deutsche Mark at the time. c. This made the after-tax value of one euro equal to one dollar. d. The number was chosen to commemorate the year of the end of World War I. e. This was the market value of the basket of currencies in one ECU. e

9 Page 9 of 14 (15) 23. The Eurozone Crisis that began in 2010 was due in part to the large current account deficits that several Eurozone countries were running. Which of the following countries was not running a current account deficit? a. Greece b. Portugal c. Ireland d. Spain e. Germany e 24. The chicken tax is a. A proposed 30% tariff on imports from China, motivated by fear of Chinese exports. b. A regressive income tax that primarily effects low income consumers who cannot afford beef. c. The tariff that several European countries placed on US exports of chicken meat in the 1960s. d. The surcharge that China now imposes on imports of chicken feet from the US. e. The 25% tariff that the US charges on imports of light trucks. e 25. In the news, President Trump s staff announced that the United States will now a. File a complaint in the WTO against China for subsidizing exports. b. Withdraw from the WTO. c. Process trade disputes bilaterally, outside of the WTO. d. Nominate a critic of international trade to be the Director General of the WTO. e. Refuse to share data on international trade and trade policies with the WTO. c

10 Page 10 of 14 (15) Part II: Short Answer Answer on these sheets in the space provided. 1. (6 points) What do the following acronyms stand for in international economics, and/or what do they mean? a. ECU European Currency Unit: the basket of European currencies to which those currencies were pegged, for several years prior to the creation of the euro, and the value of which became the initial value of the euro when it was created. b. PIGS Portugal, Ireland (or Italy), Greece, and Spain: Term may be used either for a portion of the countries who initially adopted the euro (BAFFLING PIGS), or for the countries whose economies got into trouble in the Eurozone Crisis. c. ERM Exchange Rate Mechanism: The system adopted in 1979 in which European currencies were pegged to each other. d. DFI Direct Foreign Investment: Acquisition by people or firms in one country of real assets in another country (same as FDI). e. TNC Transnational Corporation: A corporation that operates in more than one country. f. SGP Stability and Growth Pact: The agreement by Eurozone member countries that they would keep their budget deficits small (less than 3% of GDP) and pay fines if they broke this limit. 2. (4 points) True-False. Circle the correct answer. a. Since 1990, China s share of world FDI outflows has always been a very small fraction (less than 10%) of its FDI inflows. b. The United States exports more services than it imports c. Most countries of the world had pegged exchange rates during the 1950s and 1960s. True False False True False True True False True

11 Page 11 of 14 (15) d. After it was created, the euro immediately rose in value relative to the US dollar, and it has only declined recently. True False False

12 Page 12 of 14 (15) 3. (4 points) Consider a country with the following data: Y = GDP = 120 C = Consumption = 90 I = Investment = 40 G = Government purchases = 0 T = Taxes = 0 X = Exports = 50 a. Is this country running a trade surplus or a trade deficit? (circle one) ( Deficit) Surplus Deficit b. What is the value of its trade balance? 10 c. What is the value of its imports? 60 d. How much does it save? (10 points) Identify the following transactions by whether they belong in the U.S. current account or financial account, positively (contributing to a surplus in that account) or negatively. Put a plus or a minus sign in the appropriate column. Current Account Financial Account a. An American professor buys a laptop computer from a firm in Taiwan - b. A French corporation buys a chain of hotels in the United States + c. A U.S. airline borrows from a British bank to cover losses on its U.S. operations + d. Microsoft, a U.S. company, pays dividends to stockholders in Brazil - e. A Japanese tourist buys tickets for his family to enter Disney World in Orlando Florida +

13 Page 13 of 14 (15) 5. (9 points) In each of the following examples, the supply and demand diagrams that appear below show a currency that is being pegged to another at the exchange rate shown as E, and the central bank is either sterilizing or not sterilizing, as stated. For each example, do the following: i. First, fill in the first set of blanks by checking the correct responses, as indicated, to say what is happening in the initial situation. ii. iii. Second, analyze the indicated change by shifting the appropriate curve or curves in the diagram. Third, fill in the second set of blanks, by checking responses, to say what happens as a result of the change. a. Germany s central bank, the Bundesbank, is pegging the deutsche mark, DM, to the US dollar, and it is not sterilizing. i. In the initial situation, the Bundesbank is Gaining international reserves, and the German money supply is.. ü ü Losing Not changing Expanding Contracting Not changing ii. Now, the demand for exports of German cars expands. Show this in the diagram. DM/$ S $ The S $ curve shifts to the right. E D $ Q $ iii. As a result, the Bundesbank will. Increase the pace at which it intervenes. ü Decrease Not change

14 Page 14 of 14 (15) b. The Bank of Japan (BOJ) is pegging the yen ( ) to the British pound ( ), and it is sterilizing. i. In the initial situation, the BOJ is ü Buying British pounds on the foreign exchange market, and.. bonds on the Japanese bond market. ü Selling Neither Buying Selling Neither ii. Now a disaster in the UK prompts massive charitable donations by Japanese to Britain. Show this in the diagram. / E S The D curve shifts to the right. D Q iii. As a result, the BOJ will... Increase ü Decrease Not change the pace at which it buys/sells pounds, and the Japanese money supply will. Expand more rapidly Expand less rapidly Contract more rapidly Contract less rapidly ü Continue to remain constant

15 Page 15 of 14 (15) 6. (9 points) The graphs below show, in the Upper Figure, initial supply and demand in the foreign exchange market of a country, Arboria, and, below that in the Lower Figure, the same country s initial aggregate supply and demand (AD-AS). Arboria has a freely floating exchange rate for its currency, the A2 (symbol a 2 ), whose market is shown relative to the foreign currency, the yen ( ). (Residents of Arboria have their assets and liabilities both denominated in their own currency, so you only have to deal with the trade effect of any exchange rate change.) a. Draw into the Upper Figure a shift of the S curve that will cause Arboria s currency to appreciate. E = a 2 / (Upper Figure) S ( shift S to the right) b. What change in the interest rate outside of Arboria would cause this appreciation? (circle one) E 0 Rise Fall ( Fall) D c. In the Lower Figure, draw the shift or shifts in one or more curves that this appreciation will cause for Arboria. ( shift AD to the left) d. Also in the Lower Figure, mark the location of the new equilibrium that Arboria will go to in the short run (label it #1) and then in the long run (label it #2). P A P 0 A (Lower Figure) LRAS SRAS (Lower Figure) Q ( #1 is the intersection of the shifted AD with SRAS, thus at lower P and lower Y. #2 is the intersection of the shifted AD with LRAS, thus at even lower P and the initial Y) AD Y A e. Fill in the blanks in the following statement (by circling one of the offered responses in each case) so as to summarize the results of your analysis on this page. (You ll be graded based on whether this summary correctly interprets your responses in parts (a-d), whether or not they were correct.)

16 Page 16 of 14 (15) Summary: An appreciation of a country s currency causes it to experience a (temporary / permanent ( temporary)) (rise / fall ( fall)) in its GDP and a (temporary / permanent ( permanent)) (rise / fall ( fall)) in its price level.

17 Page 17 of 14 (15) 7. (6 points) Define the following terms as they are used in international economics: a. Spot market The market (for foreign exchange) in which currencies are exchanged in the present. b. Plaza Accord The agreement by major central banks in the mid-1980s to stop and/or reverse the appreciation of the U.S. dollar. c. Sterilization The use by a central bank of open market operations to offset the effect of exchangemarket intervention on the domestic money supply, thus keeping the money supply unchanged. d. Export platform A foreign direct investment done with the purpose of producing in the host country for export to a third country (i.e., other than the host or source countries). e. Dollarization Adoption by a country of another country s currency (usually the dollar) as its own, replacing any currency that it would issue and manage itself. f. Natural rate of output The level of GDP that a country can sustain without being inflationary. (Or the level of GDP corresponding to the Long Run Aggregate Supply (LRAS) Curve.)