ECOS3010: Assignment 2 

(Total: 50 marks) 

Due 11:59 pm, Friday May 28, 2021

        1. Homework must be turned in on the day it is due. Work not submitted on or before the due date is subject to a penalty of 5% per calendar day late. If work is submitted more than 10 days after the due date, or is submitted after the return date, the mark will be zero. Each assignment is worth 10% of total weight.

        2. TYPE your work (including all mathematical equations). Homework is submitted as a typed .pdf file, no exceptions. Untyped work will not be marked and will receive a mark of zero. You can draw a graph by hand, scan it, and include it as a figure in the PDF. Please don't forget to include your name and student number.

        3. Carefully explain your work.

        Question 1-4. Answer True, False or Uncertain. Briefly explain your answer. (each question 5 marks)

        1. Cooperative stabilization can help countries have a fixed exchange rate regime and avoid high inflation.

        2. The existence of international currency traders makes the exchange rate determinate.

        3. Suppose we introduce money in the model with capital. The Tobin effect suggests that an increase in the inflation rate will increase the stock of capital and consumption of (c1; c2) by individuals.

        4. Consider the three-period OLG model wherefinancial intermediaries are subject to a positive reserve requirement. A higher growth rate of money supply leads to a higher price level.

        5. (10 marks) Understanding the velocity of money and the quantity theory of money in Australia. Economists measure the velocity of money as PY =M, where PY and M are output (GDP) and money supply in nominal terms. The ratio PY =M indicates the frequency at which a unit of money is used to purchase final goods and services included in nominal GDP. In this question, we explore how the velocity of money has changed in Australia from 1975 to 2019 using money supply measured by M1 and M3. We then use the empirical findings to examine if the quantity theory of money holds in Australia. Please submit your data (keeping three decimal places) as an appendix to your assignment.

        (a) Use data from Australian Bureau of Statistics to find nominal output PY . In particular, you can use data series 5206.0 (Table 3, Column CG) to find quarterly Gross Domestic Product (PY).

        (b) From the Statistics Tables of the Reserve Bank of Australia, find money supply M measured by M1 and M3 in Table D3, Column K and Column L. Please convert the monthly data into quarterly data by keeping the values of money supply for March, June, September and December in each year.

        (c) Calculate the velocity of money PY =M using M1 and M3, respectively. Plot the two time series, velocity of money using M1 and velocity of money using M3, in one chart. Note that output is measured in millions $ and money supply is measured in billions $. It might be useful to convert them into the same units. Please use time (quarters) as the x-axis and velocity of money as the y-axis in your time series plot.

        (d) From your plot in part (c), how do velocity of M1 and velocity of M3 change over time? Can you offer an explanation to rationalize your findings? Explain.

        (e) What does the quantity theory of money suggest? Do the empirical findings you obtain from part (c) and part (d) support the quantity theory of money in Australia? Explain

        6. (10 marks) The Rate of Return Equality in practice. Consider the following data series from the Federal Reserve Bank of St. Louis (FRED) between Jan 1, 1981 and Jan 1, 2019.

        Capital Stock at Constant National Prices for United States, Millions of 2017 U.S. Dollars, Annual, Not Seasonally Adjusted (RKNANPUSA666NRUG);

        Net value added of corporate business: Net operating surplus, Billions of Dollars, An-nual, Not Seasonally Adjusted (W322RC1A027NBEA);

        Consumer Price Index: Total All Items for the United States, Index 2015=100, Annual, Not Seasonally Adjusted (CPALTT01USA661S);

        Long-Term Government Bond Yields: 10-year: Main (Including Benchmark) for the United States, Percent, Annual, Not Seasonally Adjusted (IRLTLT01USA156N);

        Consumer Price Index: Total All Items for the United States, Growth Rate Previous Period, Annual, Not Seasonally Adjusted (CPALTT01USA657N).

        (a) Construct the return on capital by using the net operating surplus divided by capital stock. Notice that the data on capital stock is in millions of 2017 U.S. dollars, but the data on net operating surplus is in billions of dollars. Please convert the data series properly to find the return on capital and include your calculated return on capital in your appendix.

        (b) Construct the real interest rate on long-term government bonds. Notice that the long-term government bond yields are nominal interest rate. Please convert the yields into real interest rates and include your calculated return on government bonds in your appendix.

        (c) Plot the return on capital that you find in part (a) and the return on government bonds that you find in part (b) in one graph, where the horizontal axis shows the years. Does the rate of return equality hold from your answers in part (a) and part (b)?

        7. (10 marks) Case study: reverse speculative attack. The Swiss National Bank (SNB) announced a peg with the euro on September 6th, 2011: "With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below one Swiss franc twenty. The SNB will enforce this minimum rate with the utmost determination. It is prepared to purchase foreign exchange in unlimited quantities." The exchange rate between the Swiss franc and the euro have been stable around 1.2 Swiss franc per euro.

        On January 15th, 2015, the Swiss National Bank abandoned the peg in its statement: "The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified." This statement sent the Swiss franc soared (appreciated) against the euro.

        Please collect your own references and resources to answer the following questions. List your references properly.

        (a) Find and plot the quarterly exchange rate between Swiss franc (CHF) and the euro as CHF per euro between 2010Q1 and 2015Q4. Briefly describe how the value of the Swiss franc changed during the sample period.

        (b) In this event, the abandon of the peg by the Swiss National bank led to an appreci-ation of the Swiss franc. Some economists call such an event "reverse speculative attack". Explain in what sense this event is a "reversed speculative attack". (Word limit: 500 words)