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To: Students Wishing to Take Babson College’s International Macroeconomics Waiver Examination

From: The Economics Division at Babson College

Attached is the syllabus used at Babson in its first-year, international macroeconomics course called Managing in a Global Economy (MGE). We hope that you find the syllabus useful in studying for the MGE waiver examination.

To prepare for this examination, you can use the textbook of your choice. If you have a favored textbook (perhaps the one you used as an undergraduate), just match the topics in Babson’s MGE syllabus with the appropriate sections of you textbook(s).

Currently, Babson College’s Economics Division is using a textbook written by Professor John E. Marthinsen entitled Managing in a Global Economy: Demystifying International Macroeconomics. This book will be published in late 2005 by Thompson/South-Western. Until then, it is available only through Babson College. If you would like to use this book to study for the waiver examination, please contact Professor John Marthinsen in the Economics Division (Luksic Hall, Room 201), or contact Neely Steinberg in Babson College’s Office of Program Management (Olin Hall, Room 320).

Good luck in your studies and good luck with the waiver examination.

Economics Division

Last Revised 05/09/23 Subject to Change 1

MGE1

TOPIC: Introduction to Country Analysis and Measures of Economic Health

READINGS: Managing in a Global Economy: Demystifying International Macroeconomics, John E. Marthinsen

Preface

Chapter 1, Introduction

Chapter 2, Understanding National Output and Income Flows

OBJECTIVES: By the end of this session, you should: Be able to differentiate Gross Domestic Product and Gross National

Product.

Understand the shortcomings of GDP and GNP as measures of economic health.

Understand the usefulness of the circular flow diagram.

Understand the major macroeconomic expenditures.

Understand macroeconomic equilibrium as it relates to desired supply and desired demand, as well as desired leakages and desired injections.

Be able to use the circular flow diagram to explain the economic effects of business-cycles.

ASSIGNMENT:

1. General questions on GNP and GDP.

a. If you marry your gardener, will GNP rise, fall, or stay the same? Explain.

b. How do improvements in product quality affect GDP? Explain.

c. Is it accurate to say that, if there are more stages of production (i.e., more steps between the production of raw materials and the production of a final product), GNP will be higher?

2. GDP versus GNP

a. Many Turkish citizens work in the European Union and send a portion of their paychecks back home each month. Assuming that Turkey is a net exporter of such labor, should Turkey’s GNP be less than, equal to, or greater than its GDP?

b. Is it true that GDP is equal to GNP plus income from foreign sources minus income paid to foreigners? Explain.


4. Circular flow

a. If GDP is the market value of all final goods and services, then why are wages included in GDP? Isn’t it double counting to include both wages and the product price?

b. Is it true that a nation’s principal sources of demand/expenditures must be equal to the components of income, or can they diverge substantially? Explain.

5. Macroeconomic equilibrium

a. At the end of each accounting period (for example, at the end of each year), does actual macroeconomic demand always equal actual macroeconomic supply (i.e., income)? Explain.

6. Which of the following economic variables are stock variables and which are flow variables?

a. GDP, GNP, saving, savings, wealth, investment, capital, money supply, exports, imports, government spending, consumption, income, earnings, assets, and liabilities.

7. Suppose gross private domestic investment equal $100 billion, government spending equals $250 billion, net exports equal - $60 billion, saving equals $70 billion, and government taxes equal $230 billion. Do you agree with this statement: “These economic forces should cause GDP to change so that business inventories fall, inflation falls, the government budget deficit falls, and the nation’s net exports increase.”

8. After each of the following items, indicate whether it is included in the United States GNP as: (C) personal consumption, (I) gross private domestic investment, (G) government spending, and (NE) net exports or (X) not included. After each entry, give a brief explanation why you chose your answer.

a. Aid to Iraq ______________

b. Government welfare payments ______________

c. Razors produced this year but unsold ______________

d. The construction of a new home ______________

e. IBM shares issued this year ______________

f. Colgate shares issued last year and bought this year __________

g. Stealth bomber research by the government ______________

h. Apples used in Mrs. Smith's Apple Pies ______________

i. Avon bonds issued and purchased this year ______________

j. Vitamins sold this year, but produced last year ______________

k. GM trucks sold to Mexico ______________


MGE2

TOPIC: Introduction to Country Analysis: Business Cycles, Interpreting Labor Market Conditions, Understanding Inflation, & Real Versus Nominal GDP


Chapter 3, Interpreting Labor Market Conditions (You are not required to read Appendix 1)

Chapter 4, Understanding Inflation and Real GDP

OBJECTIVE: By the end of this session, you should: Understand the major measures of labor market conditions, such as

unemployment, underemployment, employment, and labor force participation.

Be able to calculate the unemployment rate and employment rate.

Understand the differences among frictional, structural, seasonal, & cyclical unemployment.

Understand inflation and the major price indices, such as the GDP price deflator, consumer price index, and producer price index.

Be able to calculate the inflation rate and understand what “price stability” means.

Understand the difference between and be able to calculate real and nominal GDP.

Understand what business cycles are and how major macroeconomic variables are influenced by them.

ASSIGNMENT:1. Why don’t governments try to achieve 0% unemployment?

2. If you had to choose, is the “unemployment rate” or the “employment/population ratio” a better measure of economic health?

3. Explain how a forecasted rise in unemployment and fall in GDP might affect a company’s cash flow projections over a capital budgeting period (e.g. five years).

4. Refer to the sheet entitled Economic Information: Switzerland: 1990 – 1994. Looking at the unemployment rate, employment growth, and labor force growth, how healthy was the Swiss economy? Explain.

5. For macroeconomic analyses, which measure of inflation is best to use (i.e., IPI, CPI, or PPI)?

6. Calculate the annual inflation rate between 1991 and 1992 and between 1991 and 2001 (i.e., 10 years). (Calculate the rate using the compound formula.)

Year GDP Price Deflator1991 89.71992 91.82001 109.4


7. If the real GDP were $400 and the price index were 0.9, what would nominal GDP be?

8. Is this statement true or false? If Japanese prices decreased each year from 1990 to 2004, then Japan’s nominal GDP should have been less than real GDP in each year.” Explain.

9. Does a rise in inflation always mean a rise in nominal GDP? Explain.

10. What is a business cycle? How are business cycles measured? Are they short-term or long-term? Identify three variables that vary pro-cyclically and counter-cyclically.


Economic Information: Switzerland: 1990 - 1994Year Monetary

BaseM1 M2 Discount

Rate GDP

DeflatorCPI Real GDP

GrowthNominal Exchange

Rate SFr/$Effective Exchange Rate

(Trade-Weighted) (FX/SFr)1990 28,934 111,570 227,520 6.00% 5.7% 5.4% 2.3% 1.389 101.41991 29,247 113,744 231,370 7.00% 5.5% 5.8% 0% 1.434 100.01992 29,056 116,011 237,861 6.00% 2.6% 4.0% -0.3% 1.404 97.01993 29,498 128,212 276,200 4.00% 2.1% 3.3% -0.9% 1.477 99.11994 30,070 135,395 303,518 3.50% 1.7% 0.8% 2.1% 1.367 106.1

Year Employment Growth

Labor Force Growth

UnemploymentRate

Deficit/GDP Natural Rate of Unemployment

Real Exports of Goods &

Services Growth

Real Imports of Goods &

Services Growth

Business Sector Rates

of Return

1990 1.3% 1.3% 0.5% 0.0% 1.2% 3.0% 2.9% 9.7%1991 -0.1% 0.5% 1.1% -2.1% 1.7% -0.7% -1.7% 9.0%1992 -2.2% -0.8% 2.5% -3.5% 2.2% 3.4% -3.8% 8.5%1993 -2.6% -0.6% 4.5% -3.9% 2.8% 1.3% -1.0% 8.7%1994 -1.4% -1.2% 4.7% -3.1% 3.4% 3.9% 8.8% 9.5%

Year Real Consumption

Growth

Real Government Expenditure Growth

Gross Private Domestic Investment

Long Term Nominal Interest

Short Term Nominal Interest

Reserves & Related Items

Account/Official Reserves

Current Account

1990 1.5% 4.7% 2.6% 6.4% 8.3% -1,168 6,9411991 1.5% 1.5% -2.5% 6.2% 7.6% -973 10,3741992 -0.2% -0.1% -5.0% 6.4% 7.2% -4,383 14,2351993 -0.8% -0.7% -3.1% 4.6% 4.3% -401 17,9081994 1.4% 1.4% 6.5% 5.0% 3.5% -1,160 17,984

Components of GDP in 1995 (in Billions of Swiss Francs)

Consumption = SFr 210.2 Investment = SFr 84.2 Government Spending = SFr 50.7 Net Exports = SFr 14.2


MGE3TOPIC: Victims and Beneficiaries of Inflation


Chapter 5, Victims and Beneficiaries of Inflation

OBJECTIVE: By the end of this session, you should be able to: Explain the effects of inflation on purchasing power, higher education

costs, and property rights.

Frame the inflation issue in the context of the circular flow diagram.

Explain how inflation affects debtors and creditors, businesses and workers, governments and taxpayers, retired individuals, and whether inflation hurts the nation as a whole.

Explain the costs and benefits of indexation.

ASSIGNMENT:1. “Lenders are always hurt by an increase in the inflation rate.” Comment on

the validity of this statement.

2. “Wage earners are never helped by an increase in the inflation rate.” Comment on the validity of this statement.

3. “Fixed-income earners are always hurt by an increase in the inflation rate.” Comment on the validity of this statement.

4. “The government is always hurt by a decrease in the inflation rate.” Comment on the validity of this statement.

5. “If a nation has indexation, then the redistributive benefits and losses from inflation are eliminated.” Comment on the validity of this statement.

6. “Inflation reduces the entire nation’s standard of living.” Comment on the validity of this statement.

7. Is it correct to say that a -15% real interest rate can be either cheap or expensive depending on the situation? If so, what situation would cause a –15% real interest to be expensive? If not, give an example of how you could profit if you borrowed when the real rate of interest was -15%.

8. If the real interest rate were 3%, the past year's inflation rate were 30%, and the expected coming year's inflation rate were 40%, then what would the nominal rate of interest equal, using the approximation formula? What would the nominal interest rate equal, using the more precise formula for the nominal interest rate?

9. In many nations, nominal interest rates fall when the central bank reduces the money supply (or when it reduces the money supply growth rate). Explain why.


MGE4

TOPIC: Causes of Price Changes and Real GDP Movements


Chapter 6, Short & Medium-Term Price & Output Changes

OBJECTIVE: By the end of this session, you should be able to:

Explain aggregate supply and the Keynesian, Classical, and Intermediate ranges of the aggregate supply curve.

Explain how close a nation is to the Keynesian or Classical range.

Explain the causes of shifts along versus movements of aggregate supply curve.

Explain the causes of shifts along versus movements of aggregate demand curve.

Explain why the aggregate-demand curve slopes downward.

Combine aggregate supply and aggregate demand to analyze demand-pull inflation, cost-push inflation, and spiral inflation.

Explain the Phillips Curve.

Combine aggregate supply and aggregate demand to determine changes in a nation’s price level and real GDP due to external economic shocks.

ASSIGNMENT:

1. General aggregate supply and aggregate demand questions

a. Can a downward sloping demand curve for a nation be explained in the same way as a downward sloping demand for a firm’s product? Explain why or why not.

b. What factors affect the steepness of the aggregate supply curve?

c. What factor(s) causes a nation to move along its aggregate supply curve?

d. What factor(s) causes a nation to move along its aggregate demand curve?

e. What economic factors cause the aggregate demand curve to shift?

f. What economic factors cause the aggregate supply curve to shift?

2. Determine whether the following statements are true, false, or uncertain. Explain why you chose your answer.

a. If the Bank of Mexico (i.e., the Mexican central bank) raised interest rates in an effort to decrease inflation, the policy would be more effective if the nation’s investment demand schedule was elastic than if it were inelastic.

b. In general, the Phillips Curve shows that when inflation rises, the unemployment rate must fall.


3. Refer to the sheet entitled Economic Information: Switzerland: 1990 – 1994. Does the source of Switzerland’s price changes appear to be demand-based or supply-based?

4. Using aggregate supply and demand analysis, explain what effects the following changes have on the identified nation’s price level and real GDP. Explain your answer and draw supply and demand graphs (properly labeled) to show the effect of these changes.

a. United States: A cold snap hits the southern part of the United States and destroys 25% of the crops.

b. China: The People’s Bank of China (i.e., the central bank) tightens monetary policy.

c. Japan: The yen appreciates relative to the British pound.

d. Greece: Greek government budget deficits are reduced drastically in order to meet the conditions of the European Monetary Union’s “Stability and Growth Pact.”

e. Brazil: Brazil’s saving rate falls due to optimistic expectations.

f. United States: Turmoil between Iraq and Iran causes a sharp increase in the price of oil.

g. United States: The U.S. stock market crashes causing wealth to fall for a strong cross section of the United States.

h. Mexico: The government increases its spending and cuts taxes to stimulate the economy.

i. China: Chinese government spending increases significantly and state banks make loans to inefficient state enterprises rather than to more qualified borrowers.



BaseM1 M2 Discount

Rate GDP






Labor Force Growth

UnemploymentRate



Services Growth


Services Growth


of Return

1990 1.3% 1.3% 0.5% 0.0% 1.2% 3.0% 2.9% 9.7%1991 -0.1% 0.5% 1.1% -2.1% 1.7% -0.7% -1.7% 9.0%1992 -2.2% -0.8% 2.5% -3.5% 2.2% 3.4% -3.8% 8.5%1993 -2.6% -0.6% 4.5% -3.9% 2.8% 1.3% -1.0% 8.7%1994 -1.4% -1.2% 4.7% -3.1% 3.4% 3.9% 8.8% 9.5%


Growth







Current Account

1990 1.5% 4.7% 2.6% 6.4% 8.3% -1,168 6,9411991 1.5% 1.5% -2.5% 6.2% 7.6% -973 10,3741992 -0.2% -0.1% -5.0% 6.4% 7.2% -4,383 14,2351993 -0.8% -0.7% -3.1% 4.6% 4.3% -401 17,9081994 1.4% 1.4% 6.5% 5.0% 3.5% -1,160 17,984




MGE5

TOPIC: Monetary Aggregates, Financial Intermediaries, Banking, and Money Creation


Chapter 7, Understanding Money and Monetary Aggregates

Chapter 8, Financial Intermediaries, Banking, and Money Creation (Please read up to but not including the section entitled “Money Creation and the Banking System”)

OBJECTIVE: By the end of this session, you should:

Understand the functions of money and how inflation erodes these functions.

Understand the difference between commodity money and fiat money.

Understand the major monetary aggregates (M1, M2, reserves, and the monetary base).

Understand the advantages and disadvantages of financial intermediation.

Understand a typical bank’s balance sheet, check clearing, and the creation of money by a single bank.

ASSIGNMENT:

1. In Hungary after World War II, goods and services were purchased with pengös (the domestic currency), but inflation was so high that prices were quoted in dollars. What functions of money were pengös fulfilling in Hungary? What functions were dollars fulfilling? Explain.

2. Why do nations measure their money supplies?

3. Suppose Linda Thomas deposits $400 cash into her checking account at Citizen’s Bank in Boston. As a result of this transaction, what happens to the size of M1 and M2?

4. Why do many nations have more than one money supply measure (e.g., M1 & M2)?

5. What are the advantages and disadvantages of using financial intermediaries? Why don’t borrowers and lenders interact directly?

6. If U.S. residents take money out of their checking accounts and put it into time deposits, what will happen to the size of M1, M2, and the monetary base? Please explain.

7. When Bank A clears a check written on Bank B, …”.

a. What happens to the banking system’s excess reserves and the total level of banking system reserves?

b. What happens to Bank B’s reserves and excess reserves?


c. What happens to Bank A’s reserves and its excess reserves?

8. Is it accurate to say that as banks lend money in the form of checking accounts, the M2 money supply rises when the loan is made and then falls when the loan is spent? Explain.

9. Is it accurate to say that as banks lend money in the form of checking accounts, that the M2 money supply rises when the loan is made and then falls when the loan is paid back? Explain.

10. Assume the required reserve ratio on all deposit liabilities is 20%. Calculate the level of excess reserves for Sovereign Bank. How much can Sovereign Bank safely lend in cash? How much can it safely lend in checking accounts?

Sovereign Bank

Assets Liabilities

Reserves 40,000 Deposits 300,000

Federal Funds loans 20,000 Borrowing from the central bank 80,000

Loans 250,000 Federal Funds Borrowing 100,000

Securities 350,000 Other Liabilities 150,000

Other 40,000 Owners' Equity 70,000

11. If the reserve requirement is 10% and a depositor withdraws $500 from her checking account, by how much will the bank's excess reserves change? Explain.

12. It is the end of the banking day. You are the money trader at a bank and the bank has excess reserves, but there are no customers walking through the doors to borrow. What do you do?



BaseM1 M2 Discount

Rate GDP






Labor Force Growth

UnemploymentRate



Services Growth


Services Growth


of Return

1990 1.3% 1.3% 0.5% 0.0% 1.2% 3.0% 2.9% 9.7%1991 -0.1% 0.5% 1.1% -2.1% 1.7% -0.7% -1.7% 9.0%1992 -2.2% -0.8% 2.5% -3.5% 2.2% 3.4% -3.8% 8.5%1993 -2.6% -0.6% 4.5% -3.9% 2.8% 1.3% -1.0% 8.7%1994 -1.4% -1.2% 4.7% -3.1% 3.4% 3.9% 8.8% 9.5%


Growth







Current Account

1990 1.5% 4.7% 2.6% 6.4% 8.3% -1,168 6,9411991 1.5% 1.5% -2.5% 6.2% 7.6% -973 10,3741992 -0.2% -0.1% -5.0% 6.4% 7.2% -4,383 14,2351993 -0.8% -0.7% -3.1% 4.6% 4.3% -401 17,9081994 1.4% 1.4% 6.5% 5.0% 3.5% -1,160 17,984




MGE6

TOPIC: Money Creation by a Banking System and Central Bank Regulation of the Money Supply


Chapter 8, Financial Intermediaries, Banking, and Money Creation (Please read from the section entitled “Money Creation and the Banking System” to the end of the chapter)

Chapter 9, Regulation of the Money Supply and Monetary Effects of Fiscal Policy. (Please read from the beginning of the chapter to the section entitled “Monetary Effects of Fiscal Policy”)


Understand how the banking system creates money, and the influence of currency in circulation, customary reserves, and re-deposits in accounts other than checking accounts have on the M1 and M2 money multipliers.

Understand the influence that central banks have over the monetary base and money multiplier.

Understand major central bank assets and liabilities that relate to changes in a nation’s monetary-base.

Understand the major monetary tools of central banks, which are the required reserve ratio, open market operations, foreign exchange market intervention, and the discount rate.

Understand the role of margin requirements in monetary regulation.

ASSIGNMENT:

1. Is it possible for a country’s money supply to grow rapidly at the same time its monetary base is falling? If not, explain why not. If it is possible, explain how it is possible, and mention factors that might cause the increase.

2. What happens to the money multiplier, if anything, after Christmas, when people withdraw less cash from the banks to pay for presents?

3. Is it correct to say that the money supply changes only if the central bank wants it to change? If so, why. If not, what causes the money supply to change?

4. If interest rates fall, what, if anything, should happen to the M2 multiplier? Briefly explain.

5. Can the banking system’s excess reserves be negative? If not, explain why. If they can be negative, what has to happen?

6. What rule of thumb can be used to determine the maximum amount the banking system can lend? Why is this only a rule of thumb?

7. Suppose you saw in The Financial Times the following information on England’s monetary aggregates. Given this information, calculate the size of


the English M1 money multiplier. Given this information, calculate the size of the English M2 money multiplier.

Monetary Aggregates AmountReserves £ 220 billionExcess reserves £ 40 billionRequired reserves £ 180 billionCurrency in circulation £ 20 billionM1 money supply £ 720 billionM2 money supply £ 1,080 billion

8. How is the discount rate different from the federal funds rate? Are both markets sources of funds for the entire banking system?

9. Suppose we were evaluating Japan. Explain the effect (if any) each of the following policies/transactions by the Bank of Japan (i.e., the Japanese central bank) would have on Japan’s monetary base, money multiplier, and M2 money supply.

a. Lowering the discount rate

b. Raising the reserve ratio

c. Purchasing government securities

d. Purchasing U.S. dollars in the foreign exchange market from Brazilian citizens.

10. What happens to the U.S. monetary base if the central bank holds euros as international reserves, and the value of the euro rises? Explain.


MGE7TOPIC: Monetary Effects of Fiscal Policy and Interest Rate Determination


Chapter 9, Regulation of the Money Supply and Monetary Effects of Fiscal Policy (Please read from the section entitled “Monetary Effects of Fiscal Policy” to the end of the chapter.)

Chapter 10, Short and Medium Term Interest-Rate Changes


Understand the monetary effects of fiscal policy. Understand the components of nominal interest rates, which are real

interest rate, expected inflation, market and country risk, credit risk, taxes, and maturity.

Understand how real interest rates are determined in the real loanable funds market

ASSIGNMENT:

1. Monetary effects of fiscal policy

a. What impact does an increase in government spending have on the nation’s monetary base? Explain.

b. What impact does an increase in government taxes have on the nation’s monetary base? Explain.

2. Suppose the South African government increased the budget deficit and financed it by borrowing in the domestic private capital markets. Explain the effect this would have on South Africa’s monetary base, M2 money multiplier, and M2 money supply. How would your answer differ if the South African government borrowed in the international markets and then converted the funds into the South African rand?

3. Fill in the following table. If the factors in the first column change as indicated, in which direction will the variables in the remaining columns change (i.e., rise (+), fall (-), stay the same (0))? Consider only the immediate and direct effects of these changes. Provide a brief explanation for each cell.


Impact Monetary Base

Excess Reserves

Total Reserves

An increase in bank borrowing from the central bank

Increased borrowing in the federal funds market

Decline in the required reserve ratio

The President uses a budget surplus to reduce taxes.

Open market sales of government securities by the central bank

4. Explain why companies with equal default risk borrow at different interest rates, just because they are in different countries.

5. “If the supply of loanable funds rises, the money supply must rise and vice versa.” Explain whether you agree or disagree with this statement.

6. What effect, if any, does each of the following shocks (only consider the initial effect) have on the Japanese real interest rate? Briefly explain and provide a supply and demand diagram that shows your conclusion. Make sure that you label all axes and curves.

a. A decrease in the Japanese money supply with no change in prices or inflation.

b. A decrease in global lending to Japan.

c. Increased Japanese saving.

d. An increased government budget deficit.

e. Speculative short-term international capital inflows.

f. An increase in real GDP.

g. An increase in expected inflation.

7. Is it accurate to say that central banks have complete control over nominal interest rates? Explain why or why not.


MGE8

TOPIC: Introduction to the Foreign Exchange Market


Chapter 11, Foreign Exchange Markets (You are not responsible for Appendix 1 or Appendix 2)

OBJECTIVES: By the end of this session, you should: Understand exchange rates, their reciprocal nature, as well as

appreciation and depreciation of a currency.

Be able to determine whether to use the bid rate or ask rates in foreign exchange transactions.

Understand the major characteristics of the spot foreign exchange market and the why spot transactions do not change a nation’s monetary base.

Understand the major characteristics of the forward market in foreign exchange and how to use this market to hedge transaction exposures.

Be able to explain why and by how much forward rates should differ from spot rates.

Understand the differences among bilateral, effective, nominal, and real exchange rates.

Understand interest parity

ASSIGNMENT:

1. In terms of the yen/peso exchange rate, is it always true that if the peso rises in value, the yen must fall in value? If it is not possible, explain why. If it is possible, provide an example.

2. Suppose Sue Flay, a U.S. investor, purchases $1.5 million of British pounds in the foreign exchange market. What effect does this transaction have on the United States and British monetary bases and the M2 money supply? Explain using T-accounts. (Assume the exchange rate is $1.50/£)

3. Using the table below, calculate how many dollars you would end with if you started with $1,000 and then (Please be prepared to show all your calculations):

a. Converted the $1,000 dollars to Swiss francs,

b. Converted the Swiss francs to euros,

c. Converted the euros to pounds, and

d. Converted the pounds (£) to US dollars.


Bid Ask

Dollars/pound $1.50/£ $1.52/£

Swiss francs/euro SFr 2.00/euro SFr 2.03/euro

Swiss francs/dollar SFr 1.30/$ SFr 1.32/$

Pounds/euro £0.70/euro £0.72/euro

4. Using the information in Question 3, calculate the bid and ask Euro/dollar rate by using Swiss francs as the vehicle currency.

5. Is the foreign exchange market a good example of a market that has pure competition or imperfect competition? Explain.

6. Suppose there were strong speculative capital flows into the euro from the Nigerian naira due to international political turmoil. Explain what would happen to the European Monetary Union’s money supply, monetary base, and spot exchange rate.

7. What is the forward foreign exchange market? Explain how an Italian exporter, who is due to receive 30 million Japanese yen in 90 days, can use the forward market to reduce risk. Assume the exchange rate is ¥150/€.

8. Given the information below, determine whether there is interest parity between Switzerland and Mexico. (Remember that interest parity implies there is no way to make arbitrage profits.)

Swiss franc nominal interest rate (annual) 2.00% - 2.10%

Mexican nominal interest rate (annual) 3.00% - 3.20%

Spot exchange rate Ps 4.00 - 4.04/SFr

One year forward exchange rate Ps 4.05 - 4.07/SFr

9. To answer these questions, refer to the sheet entitled Economic Information: Switzerland: 1990 – 1994.

Give a brief explanation of the “effective” exchange rate.

Using the effective exchange rate, during the 1990 to 1994 period was Switzerland’s exchange rate change a source of expansion or contraction?

Between 1990 and 1992, did Swiss imports and exports behave as you would have expected given the change in the Swiss franc’s effective exchange rate?



BaseM1 M2 Discount

Rate GDP






Labor Force Growth

UnemploymentRate



Services Growth


Services Growth


of Return

1990 1.3% 1.3% 0.5% 0.0% 1.2% 3.0% 2.9% 9.7%1991 -0.1% 0.5% 1.1% -2.1% 1.7% -0.7% -1.7% 9.0%1992 -2.2% -0.8% 2.5% -3.5% 2.2% 3.4% -3.8% 8.5%1993 -2.6% -0.6% 4.5% -3.9% 2.8% 1.3% -1.0% 8.7%1994 -1.4% -1.2% 4.7% -3.1% 3.4% 3.9% 8.8% 9.5%


Growth







Current Account

1990 1.5% 4.7% 2.6% 6.4% 8.3% -1,168 6,9411991 1.5% 1.5% -2.5% 6.2% 7.6% -973 10,3741992 -0.2% -0.1% -5.0% 6.4% 7.2% -4,383 14,2351993 -0.8% -0.7% -3.1% 4.6% 4.3% -401 17,9081994 1.4% 1.4% 6.5% 5.0% 3.5% -1,160 17,984




MGE9

TOPIC: Foreign Exchange Rate Determination


Chapter 12, Short and Medium-Term Exchange Rate Changes

OBJECTIVE: By the end of this session, you should be able to: Explain the major participants in the foreign exchange markets.

Explain how nominal exchange rates are determined and what causes them to change.

Explain the effect foreign exchange transactions have on a nation’s monetary base.

Understand the costs and benefits of fixed exchange rate systems, fixed-band systems, crawling peg systems, managed floats, and flexible exchange rates.

Understand the costs and benefits of a single global currency.

ASSIGNMENT:

1. What is the “real” exchange rate, and why are changes in it more important than changes in the nominal exchange rate.

2. Does the “real exchange rate” have meaning only for a country, or does it also have meaning for a company? Explain.

3. Suppose England’s real exchange rate relative to the United States was 1.32. What does this mean? Is there an opportunity to arbitrage the markets? If so, explain how, and if not, explain why not.

4. Suppose England decided to fix its exchange rate relative to the Euro as a precursor to joining the European Monetary Union. Under these circumstances, is it possible for England’s real exchange rate to change?

5. Suppose you picked up the Wall Street Journal and read the following headline: “U.S. dollar rises on international markets.” After reading the article, you discover that the U.S. dollar did rise against the Canadian dollar, Mexican peso, and Japanese yen, but it fell against the euro, Swiss franc, British pound, Thai baht, and Indian rupee. Is this a case where the Wall Street Journal reporter should have written a more carefully articulated article? Was he/she wrong to make a general statement (i.e., “U.S. dollar rises on international markets”) when the dollar moved in different directions against different currencies?


6. Using supply and demand analysis, explain the effect each of the following economic changes has on the Swedish Krone value of the Brazilian real (the “real” is the Brazilian currency). Also, what effect do these transactions have on the respective countries’ monetary bases?

a. A decline in the real interest rate on Krone securities relative to real securities.

b. A rise in Brazilian real GDP relative to Sweden.

c. A decline in Sweden’s inflation rate relative to Brazil.

d. The Bank of Brazil intervenes to raise the value of the real.

e. A growing expectation that Brazil will impose exchange controls on the real.

7. Suppose you were an investment portfolio manager, and you were currently satisfied with the composition of your internationally diversified portfolio. What changes would you make in the portfolio if you expected the U.S. money supply to grow rapidly in the future relative to the euro money supply? Explain.

8. What are the major advantages of having a global currency? (What name would you give to this global currency?)

9. Why are fixed exchange rates a problem for any nation coming under speculative pressure?


MGE10

TOPIC: Balance of Payments

READINGS: Managing in a Global Economy: Demystifying International Macroeconomics, John E. MarthinsenChapter 13, The Balance of Payments, Sections (Please read to What Causes Surpluses and Deficits in the Balance on Goods and Services)

OBJECTIVE: By the end of this session, you should be able to:

Differentiate the principal parts of the balance of payments.

Explain why the balance of payments is like a “sources and uses of funds statement.”

Explain the economic meaning and significance of balance of payments deficits and surpluses in the merchandise trade balance, balance on goods and services, balance on goods, services, and net income, current account balance, and overall balance.

ASSIGNMENT: 1. Explain the economic meaning and usefulness of the following balance of

payments concepts: merchandise trade balance; balance on goods and services; balance on goods, services and net income; current account balance; and overall balance.

2. Is it correct to say that a current account deficit is bad for a nation? If so, explain why. If not, give an example of how it might be good.

3. Which of the following statements (if any) is correct?

a. “The entire balance of payments always sums to zero?”

b. “As a whole, the balance of payments must equal zero, and if it does not, the international reserves account will adjust to make it equal zero?”

c. “As a whole, the balance of payments must equal zero, and if it does not, economic forces will cause the sum to equal zero.”

4. What measure of balance of payments gives the best picture of whether:

a. A nation is paying its own way?

b. The central bank is intervening in the foreign exchange markets?

c. A nation's exchange rate is in equilibrium?

d. A nation is under pressure to devalue or revalue its currency?

e. There is capital flight from the nation?


MGE11

TOPIC: Business Decisions Related to Balance of Payments & Exchange Rate Changes


Chapter 13, The Balance of Payments, (Please read from What Causes Surpluses and Deficits in the Balance on Goods and Services to the end of the chapter.)

Finance and economics: Money in, money out, The Econo mist ; Oct 23, 1999.

OBJECTIVE: By the end of this session, you should be able to:1. Use balance of payments figures to make business decisions.

2. Understand the meaning of and difference between leading and lagging payments and receipts.

3. Understand two major balance of payments identities:

a. CA + F/KA + ORA = 0 and

b. NE = (S - I) + (T - G)).

ASSIGNMENT:1. Use the article entitled Money in, money out to answer the questions in this

section.

a. This article focuses on China’s balance of payments. Begin your answer by listing the three major accounts in all nations’ balance of payments, and then, based on the article, fill in the particular 1998 figures for China in each of these accounts. Please be very careful of the signs. Indicate “+” when the figure is positive, “–” when it is negative, and “0” when there was no change or no entry.

b. Given your answer in the previous question, indicate if the People’s Bank of China (i.e., the Chinese central bank) was intervening in the foreign exchange market(s). If it was not intervening, explain how you know. If it was intervening, explain the effect this intervention has, if any, on China’s monetary base and level of international reserves.

c. Explain where the $145 billion of foreign exchange reserves fit, if at all, into China’s 1998 balance of payments statistics.

d. Draw the supply and demand curves for the Yuan relative to the euro. Make sure you correctly label both axes and all curves. Please read the last paragraph of the article and show what you predict will happen to the value of the Yuan. Briefly explain why you predict supply and/or demand will change in the direction indicated.

2. To answer these questions, refer to the sheet entitled Economic Information: Switzerland: 1990 – 1994

a. What, if anything, can be said about Switzerland's intervention in the foreign exchange markets?

b. Calculate the financial/capital account of Switzerland’s balance of payments between 1990 and 1994.


3. Does a country with a deficit in its balance of goods and services account also have to have a budget deficit? Under what conditions could it have a budget surplus? Fully explain. Is there any economic reason why a nation with a budget deficit would be more likely to have a deficit in its balance on goods and services account?

4. Mexico had sizable capital inflows in 1996 (i.e., a year after the currency crisis):

a. What effect should these flows have had on Mexico’s Current Account, Financial/Capital Account, and/or Reserves Account?

b. What effect should these flows have had on the international value of the Mexican peso?

c. What effect should these flows have had on Mexico’s monetary base?

5. Suppose that you had business holdings in a small country that had borrowed from the International Monetary Fund because of serious debt problems. The Fund recommended that the small country peg its exchange rate at the equilibrium level. You observed that the country's foreign exchange reserves were falling very rapidly. Do you think the country's exchange rate is undervalued or overvalued? Why? As a business manager, what actions should you take, if any, to increase your profits or to protect your business interests? Explain your answer using supply and demand analysis.

6. In 1982, Mexico precipitated an international debt crisis when it defaulted on billions of dollars of international loans. As a result, the international financial community virtually stopped all loans to Mexico. Suppose it was 1981 (one year before the crisis), and you knew the crisis would occur next year. Would you be able to predict what will happen to Mexico’s current account balance? What major factor(s) could complicate your prediction?



BaseM1 M2 Discount

Rate GDP






Labor Force Growth

UnemploymentRate



Services Growth


Services Growth


of Return

1990 1.3% 1.3% 0.5% 0.0% 1.2% 3.0% 2.9% 9.7%1991 -0.1% 0.5% 1.1% -2.1% 1.7% -0.7% -1.7% 9.0%1992 -2.2% -0.8% 2.5% -3.5% 2.2% 3.4% -3.8% 8.5%1993 -2.6% -0.6% 4.5% -3.9% 2.8% 1.3% -1.0% 8.7%1994 -1.4% -1.2% 4.7% -3.1% 3.4% 3.9% 8.8% 9.5%


Growth







Current Account

1990 1.5% 4.7% 2.6% 6.4% 8.3% -1,168 6,9411991 1.5% 1.5% -2.5% 6.2% 7.6% -973 10,3741992 -0.2% -0.1% -5.0% 6.4% 7.2% -4,383 14,2351993 -0.8% -0.7% -3.1% 4.6% 4.3% -401 17,9081994 1.4% 1.4% 6.5% 5.0% 3.5% -1,160 17,984




MGE12

TOPIC: Flexible Exchange Rates with Real & Monetary Sector Shocks


Chapter 14, Putting It All Together

Chapter 15, Economic Shocks to Nations with Flexible Exchange Rates (You are not required to read Appendix 1 or Appendix 2)

OBJECTIVES: By the end of this session, you should be able to:

Use the three-sector model to conduct macroeconomic analyses of countries with flexible exchange rates.

Understand the primary effects of exogenous shocks to nations with flexible exchange rates -- particularly, with respect to changes in average price level, real and nominal GDP, unemployment and employment rates, real and nominal wages, real and nominal interest rates, monetary base, money supply, gross private domestic investment, real and nominal exchange rates, as well as changes in the nation’s Current Account, Capital/Financial Account, and Official Reserves Account.

Understand the effects of contractionary monetary policy on nations with flexible exchange rates.

ASSIGNMENT:

1. England has not joined the European Monetary Union, but it is a member of the European Union. As a result, England has a flexible exchange rate and retains its own currency, the pound sterling. Suppose England’s unemployment rate began to rise and the government passed an investment tax credit to help stimulate the economy. Explain the effect this policy would have on the nation's real and nominal interest rates, real and nominal GDP, gross private domestic investment, unemployment rate, inflation rate, real exchange rate, nominal exchange rate, current account balance, financial/capital account, and reserves account. (Definition of Investment Tax Credit: A company may claim an investment tax credit for a percentage of the net costs paid in a taxable year for tangible assets that qualify under government rules. In short, if you invest, a portion of your investments can be used to reduce taxes and increase your after tax profits. Usually, these assets are eligible for depreciation or amortization treatment, like new buildings and machinery)

2. How would your answer to question #1 change if a politically unstable country (e.g., Zimbabwe) and not England passed an investment tax credit. To answer this question, think in terms of how capital mobility facing an unstable county is different from England and the effect it would have.

3. How would your answers to question #1 change if England pursued contractionary monetary policy?

4. What factors will increase or decrease the level of international capital mobility between one nation and the rest of the world?


MGE13

TOPIC: Fixed Exchange Rates with External Shocks & Domestic Monetary Shocks


Chapter 16, Economic Shocks to Nations with Fixed Exchange Rates

OBJECTIVE: By the end of this session, you should be able to

Use the three-sector model to conduct macroeconomic analyses of countries with fixed exchange rate systems.

Understand the primary effects and feedback effects that external shocks and monetary policy have on nations with fixed exchange rates.

ASSIGNMENT:

1. A 1991 The Wall Street Journal cover page article entitled “Foreign Rate Increases May Worsen Slump” explained how the German central bank raised domestic interest rates in order to reduce inflation below the 3% level. At the same time, the U.S. central bank reduced domestic interest rates to fight the deepening recession in the United States.

a. Explain the pressures that rising German real interest rates put on the other European Union (EU) countries' currencies. Specifically, assume exchange rates within the EU were absolutely fixed. Explain the economic effects a rise in the real German interest rate put on the DM/FF exchange rate and what the French central bank (i.e., the Bank of France) would have to do to keep the exchange rate fixed.

b. Explain the economic effects the rise in German real interest rates put on the DM/FF exchange rate and what the German central bank (i.e., the Bundesbank) would have to do to keep the exchange rate fixed.

c. What is the Phillips Curve? Are your results in question (1a) consistent with the Phillips Curve?

2. In 1991, Argentina adopted a currency board that had the responsibility to maintain a fixed exchange rate between the Argentine peso and the U.S. dollar ($1 = 1 Argentine Peso). Through the Convertibility Law, Argentina also established that each peso in circulation had to be 100% collateralized with reserves in the Central Bank, assuring 100% coverage of Argentine monetary base. Assume the government promised to reduce the surging unemployment rate by trying to stimulate significant new economic growth by means of expansionary monetary policy. Since it would be constrained by the Convertibility Law from increasing the monetary base, suppose the central bank expanded the money supply by reducing the reserve ratio. Explain the economic effects that expansionary monetary policy would have on Argentina's real and nominal GDP, monetary base, money supply, real and nominal interest rates, current account, financial/capital account, level of international reserves, real investment spending, unemployment rate, inflation rate, real exchange rate, and velocity of money.


MGE14

TOPIC: Burden of the Government Debt & the Automatic Stabilizers

READINGS: Macroeconomics: Private and Public Choice, James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David Macpherson, (10th edition), 2003

Special Topic 5, “The Federal Budget and the National Debt (pp. 696 – 705)

OBJECTIVES: By the end of this session, you should:

Understand the difference between government debt and deficits.

Have a framework for evaluating the costs and benefits of government deficits.

ASSIGNMENT:

1. At the end of 2004, the gross federal debt was approximately $7,500 billion, and it is highly likely that it will grow much larger during the coming decade. Many people are concerned that the government could go bankrupt and that the U.S. economy could face severe consequences. Under what conditions can a government go bankrupt? Is it possible for the U.S. government to go bankrupt?

2. Is the U.S. government debt a burden on future generations? Does the U.S. government eventually have to pay off its debt?

3. The Brazilian budget deficit has grown to become a large portion of GDP. Explain how it was possible for Brazil’s actual budget deficit to grow at the same time that former President Fernando Henrique Cardoso was discretionarily cutting government spending and raising tax rates.

4. What are “automatic stabilizers”? What effect do they have on the economy? In other words, what do they automatically stabilize, and how do they automatically do it?

5. To answer these questions, refer to the sheet entitled Economic Information: Switzerland: 1990 – 1994

a. Was Switzerland's fiscal policy loose or tight?

b. What fiscal policy would you have recommended to the Swiss authorities if they wanted to improve Swiss economic performance? Please explain using AS/AD analysis.



BaseM1 M2 Discount

Rate GDP






Labor Force Growth

UnemploymentRate



Services Growth


Services Growth


of Return

1990 1.3% 1.3% 0.5% 0.0% 1.2% 3.0% 2.9% 9.7%1991 -0.1% 0.5% 1.1% -2.1% 1.7% -0.7% -1.7% 9.0%1992 -2.2% -0.8% 2.5% -3.5% 2.2% 3.4% -3.8% 8.5%1993 -2.6% -0.6% 4.5% -3.9% 2.8% 1.3% -1.0% 8.7%1994 -1.4% -1.2% 4.7% -3.1% 3.4% 3.9% 8.8% 9.5%


Growth







Current Account

1990 1.5% 4.7% 2.6% 6.4% 8.3% -1,168 6,9411991 1.5% 1.5% -2.5% 6.2% 7.6% -973 10,3741992 -0.2% -0.1% -5.0% 6.4% 7.2% -4,383 14,2351993 -0.8% -0.7% -3.1% 4.6% 4.3% -401 17,9081994 1.4% 1.4% 6.5% 5.0% 3.5% -1,160 17,984




MGE15

TOPIC: Applications: Using Economic Theories to Explain and Understand Current Global Economic Changes

READING: Readings from business periodicals (e.g., The Wall Street Journal or The Economist) will be distributed prior to class.

OBJECTIVE: By the end of this session you should be able to use economic theories and the Three-Sector Model to explain and understand current global economic events.

ASSIGNMENT:

The articles and questions will be put on Blackboard prior to class.

Copyright © John Marthinsen Last Revised 5/9/2023 31

MGE16

TOPIC: Long Run Economic Growth and Inflation

What Causes Nations to Grow?

Purchasing Power Parity

READING: Macroeconomics: Private and Public Choice, James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David Macpherson, (10th edition), 2003

Chapter 16, "Economic Growth” (pp. 370 – 391)

Global Financial Markets, Ian H. Giddy, 5, Lexington Books, Chapter 5, Exchange Rates, Inflation and Interest Rates: An Integrated Framework (pp. 125 bottom – pp. 137)

OBJECTIVE: By the end of this session you should:

Understand why nations grow in the long run and the role of diminishing returns, technology, and total factor productivity.

Understand if there are institutional and structural prerequisites for long-term growth.

Understand the differences among the law of one price, absolute purchasing power parity, and relative purchasing power parity.

Understand the difference between the equation of exchange and Quantity Theory of Money.

Be able to relate the Quantity Theory of Money to Absolute Purchasing Power Parity.

ASSIGNMENT:

1. Link the variables in the equation of exchange to the purchasing power parity theory, and then use the Quantity Theory of Money to explain why exchange rates change.

2. Is the velocity of money just another name for the money multiplier? Explain.

3. How is the Equation of Exchange similar to and different from the Quantity Theory of Money?

4. Using the Equation of Exchange, explain how an increase in the money supply affects the economy. How important is it for the velocity of money to remain constant over time?

5. Determine whether the following statements are true, false, or uncertain. If any one is false, change it so that the statement is correct.

A. An increase in nominal income will increase the velocity of money

B. A decrease in the real rate of return on bonds will increase the velocity of money.

C. A rise in the real return on equity will increase the velocity of money.

D. An expected decline in the rate of inflation will increase the velocity of money.


6. Suppose the Swiss National Bank wished to have inflation grow at a 2% level over the coming year. Swiss GDP is expected to grow from SFr 8,000 million to SFr 8,080 million. The velocity of money for M2 is expected to grow from 4.00 to 4.24. Calculate the percentage change in the money supply needed for the Swiss National Bank to accomplish its goal. Given you answer, list the tools that the Swiss National Bank would use to change the money supply and in which direction they would have to change.

7. Suppose you are in a meeting with the CFO, Treasurer, and Treasury staff at corporate headquarters. The discussion suddenly focuses on expanding operations in Latin America, in general, and in Brazil, in particular. A colleague at the table mentions that Brazil is probably not a good prospect for investment, because she fears that the nation may return to the 7,000% inflation rate it once experienced. When asked for the cause of the hyperinflation, your colleague says that most of her fears are centered on the potential for the Brazilian government to pursue expansionary fiscal policy. All eyes turn toward you (the most recent MBA) for a comment on the validity of your colleague’s statement. The question boils down to this: Can expansionary fiscal policy without an accommodating increase in money supply cause hyperinflation? Use the equation of exchange as the basis for your reply, and explain if a 7,000% inflation rate is possible under these conditions. If it were possible, what would have to occur to make it happen? If it cannot happen, explain why it is impossible?

8. What is the law of one price, and how is it different from the absolute purchasing power parity theory? How is the absolute purchasing power parity theory different from the relative purchasing power parity theory?

9. What are the main problems with purchasing power parity as a tool for forecasting exchange rates?


economy - babson college · web viewexplain why you chose your answer. if the bank of mexico (i.e.,...

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