THE UNIVERSITY OF HONG KONG School of Economics & Finance st Semester Examination. Economics: ECON0302 International Finance Dr C W Yuen

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1 School of Economics & Finance st Semester Examination Economics: ECON0302 December 15, :30-4:30p.m. OPEN BOOK. Answer ALL questions in the space provided. True/False/Uncertain Questions (10 points each) State whether each of the following statements is true, false, or uncertain; then provide a brief explanation to support your answer. 1. An increase in the foreign demand for exports from the domestic country will lead to a rise in the demand for domestic currency and consequently a depreciation of the foreign currency in the foreign exchange market. 2. Although monetary policy loses much of its power in in uencing real output and employment under xed exchange rates, scal policy can always be used as an e ective stabilization tool to maintain internal and external balances. 3. While xed exchange rates are better able to stabilize output, oating exchange rates are better able to stabilize prices. 4. Under the intertemporal approach to balance of payments, the present-value condition that applies to the trade account may not also apply to the current account. 5. It is impossible for all countries in the world to adopt one common currency. 6. Business cycles are larger and more prevalent in an open economy than in an otherwise closed economy. 7. Speculative attacks on a currency board would generate both a currency crisis and a banking crisis. Analytical Question (30 points) Using the IS-LM-BP model, analyze the e ects of an oil price shock on a small open economy (such as Hong Kong) in the short run and the long run. 1

2 ECON0302 Chi-Wa Yuen Final Exam Fall 2003 True/False/Uncertain Questions (10 points each) State whether each of the following statements is true, false, or uncertain; then provide a brief explanation to support your answer. 1. The empirical failure and weak forecasting power of structural models of exchange rates imply that economic theories are no better than pure statistical (time series) models and technical analysis in understanding exchange rate behavior. 2. The presence of the J-curve is clear evidence against the elasticity approach to balance of payments. 3. While oating exchange rates are better able to stabilize output, xed exchange rates are better able to stabilize prices. 4. According to the intertemporal approach to balance of payments, an open economy hit by an adverse supply shock will su er a deterioration in its current account. 5. In terms of facilitating international trade and investment, the most e cient monetary system is one where all countries in the world adopt one common currency. 6. Business cycles are larger and more prevalent in an open economy than in an otherwise closed economy. 7. In retrospect, the Asian nancial crisis in was not truly a self-ful lling currency crisis. Analytical Question (30 points) Earlier this year, Hong Kong was hit by SARS (severe acute respiratory syndrome). Using the IS-LM-BP model, analyze the e ects of SARS on the HK economy in the short run and the long run. 1

3 School of Economics & Finance st Semester Examination Economics: ECON0302/ December :30a.m. 11:30a.m. Open Book. Answer ALL questions in the space provided. Extra sheets will NOT be graded. (A1) (A2) (A3) (A4) (A5) (B1) (B2) True/False/Uncertain Questions (50 points) State whether each of the following statements is true, false, or uncertain, and provide a brief explanation to support your answer. The Ricardian Equivalence Theorem implies that trade deficits can never be a consequence of fiscal deficits. According to the simple supply-demand model of exchange rate determination, an increase in the foreign demand for exports from the domestic economy will lead to a rise in the demand for domestic currency and consequently a fall in the exchange rate (defined as domestic currency value of foreign currency) in the foreign exchange market. Under a floating exchange rate regime, any balance of payments deficits (surpluses) can automatically be corrected through a depreciation (an appreciation) of the domestic currency. According to the monetary approach, an importation of foreign workers))which increases the domestic work force and enlarges domestic production))will result in an improvement in the balance of payments and an appreciation of the local currency. While the first and third generation models of speculative attacks on fixed exchange rate regimes attribute currency crises to wrong fundamentals, the second generation model says that such regimes may collapse under self-fulfilling expectations even when the fundamentals are right. Analytical Questions (50 points) Supply Shocks vs. G-Shocks as Sources of Business Cycles (25 points) As sources of economic fluctuations, what are the major differences between supply (or productivity) shocks and government spending shocks? Does your answer depend on whether a) the shocks are transitory or permanent? b) the economy in question is small or large? Mundell s Principle of Effective Market Classification (25 points) In class when discussing the problem of assigning the two policy instruments))monetary policy (MP) and fiscal policy (FP)))to the two policy targets of internal balance (IB) and external balance (EB) under a fixed exchange rate regime, we have analyzed the case where both the IB and EB curves are downward-sloping. a) Using the Mundell-Fleming model, explain why the IB curve is necessarily downwardsloping while the EB curve may be either upward-sloping or downward-sloping. Where in your analysis have you applied the assumption of fixed exchange rates? b) State the condition under which the EB curve is upward-sloping. In terms of absolute values, can you determine whether the IB curve is steeper than the EB curve (as in the case where both curves are downward-sloping) or the other round? c) Based on your answer to (b) above and using the IB-EB diagram, show whether (as in the case we discussed in class) fiscal policy should be assigned to internal balance and monetary policy to external balance. Does your conclusion depend on the degree of capital mobility?

4 B.Econ.: Final Part II/III Examinations B.Fin.: Final Part II/III Examinations B.Soc.Sc.: Final Part III Examination B.A.: Final Part II Examination S.Sc.: Final Part II Examination Economics: May 1999 Open Book. Answer ALL questions in the space provided. Extra sheets attached will NOT be graded. Multiple Choice Questions (40 points) Circle what you think is the best answer. (B1) (B2) (B3) Analytical Questions (60 points) PPP and IRP under the Linked Exchange Rate System Under the current linked exchange rate system, (the relative version of) the purchasing power parity (PPP) implies that HK should have the same inflation rate as the US whereas the interest rate parity (IRP) implies that the nominal interest rates in the two places should also be the same. However, data in the past decade show that the inflation rate was significantly higher in HK than in the US. Recent evidence (especially during the Asian financial crisis) also shows that the nominal interest rate was much higher in HK than in the US. Can these be taken as solid evidence to reject both the PPP and the IRP? If not, what alternative arguments or evidence can you provide to support the two parity conditions in the context of Hong Kong? Alternative Approaches to the Balance of Payments In class, we have discussed five alternative approaches to the balance of payments. What are they? In bullet point form, list the strengths and weaknesses of each approach in general. Which approach is most useful in helping us understand the effects of exchange rate devaluation? Explain. EMU as an Optimum Currency Area? As an exchange rate arrangement, what is the difference between the European Monetary System (EMS) and the Economic and Monetary Union (EMU). Applying the theory of optimum currency area, explain the economic reasons behind the formation of the EMU and the economic factors that govern its success/failure.

5 Bachelor of Economics: Final Part II & III Examinations Bachelor of Finance: Final Part III Examination Bachelor of Social Sciences: Final Part II Examination Bachelor of Arts: Final Part I Examination Bachelor of Science: Final Part II Examination Economics: May 1998 Open Book. Please answer ALL questions in the space provided. Multiple Choice Questions Please circle what you think is the correct answer. (B.1) (B.2) (B.3) (B.4) (B.5) True/False/Uncertain Questions (50 points) State whether each of the following statements is true, false, or uncertain, and provide a brief explanation to support your answer. The empirical regularity that, when expressed in terms of the same currency, price levels are lower in poorer countries and higher in richer ones is a clear rejection of the purchasing power parity. The two (uncovered and covered) versions of interest rate parity conditions imply that the expected future spot exchange rate must be equal to the forward exchange rate. While monetary policy cannot affect output in a small open economy under the fixed exchange rate regime, the same is true for fiscal policy under the floating rate regime. According to the intertemporal approach to balance of payments, a small open economy hit by a temporary adverse supply shock will suffer a deterioration in its current account. In facilitating international trade, the most efficient system is one where all countries in the world adopt the same currency.

6 The University of Hong Kong Bachelor of Economics : Final Parts II & III Examination Bachelor of Finance : Final Parts II & III Examination Bachelor of Social Sciences : Final Part III Examination Bachelor of Science : Final Part II Examination May 1997 Open Book. Please answer ALL questions in the space provided. Multiple Choice Questions (30 points) Please circle you answer on the question paper. True/False/Uncertain Questions (45 points) State whether each of the following statements is true, false, or uncertain and provide a brief explanation to support your answer. 1. Final vs. Intermediate Goods in National Income Accounting GNP accounts avoid double counting by including only the value of final goods and services sold on the market. The measure of exports and imports used in the GNP accounts should therefore be defined to include respectively only exports and imports of final (and not intermediate) goods and services from abroad. 2. The Bretton Woods System vs. the European Monetary System Since both the Bretton Woods System and the EMS are essentially `fixed' exchange rate systems, the latter is doomed to failure given the experience of the former. 3. Monetary Expansion and Currency Values When the domestic money supply is increased, the exchange rate (defined as the domestic currency value of foreign currency) will appreciate, irrespective of whether it is done through open market operations or foreign exchange operations. (C) Long Question: A Dutch Disease? (25 points) Consider an oil producing and exporting country "Opec" operating under a floating exchange rate regime and facing perfect capital mobility. Suppose that, due to the discovery of oil reserves under the "Greasy Ocean", the oil production in "Opec" is doubled. (a) Using the Mundell-Fleming model, explain how the oil discovery in "Opec" will affect its price level and trade balance position as well as its levels of interest rate, exchange rate, and national income. (b) How will the effects you find in (a) be altered if "Opec" adopts a fixed exchange rate regime. Explain. (c) How would your answers to (a) and (b) above be affected if you replace the Mundell- Fleming model with the monetary approach as your framework of analysis. Explain the economic intuition behind your results.