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ECN 410

Fall 2020 Midterm I

1. Assume the US is currently running a current account deficit (CA0  < 0) and government budget deficit (G0 > T0), and Donald Trump wins re-election in the upcoming presidential election. He then delivers on his promise to cut the payroll tax to stimulate economic recovery.

a)  What is the result of this fiscal policy response on the government budget deficit and public debt level of the US?

b) Use the definition of the current account to explain how the changing government budget deficit will also impact the trade balance. How do you know?

2. Suppose the US economy quickly recovers from the current recession and enters an expansionary phase of the business cycle. (Y >  ; π > π* ; U < )

a) How would the Federal Reserve react to such an expansionary phase of the business cycle   based upon their inflation target rule? Use the simultaneous equilibrium model to illustrate and

show the effects of such monetary policy in the short run.

b) How would the resulting changes in the money and foreign exchange markets above work to    offset the expansion and move the economy back to its target? (Hint: there are two channels here)

3. Suppose the Chinese economy recovers more quickly than the US economy from our current global recession. Illustrate and describe how this asymmetric recovery across countries will impact our            simultaneous equilibrium model from the perspective of the US. Be sure to highlight the changes in the rate of return on $-denominated assets, the rate of return on yuan (CNY)-denominated assets and the    exchange rate ($/CNY).

4. The dollar has been steadily depreciating in value relative to other major global currencies, including the Japanese Yen, over the past six months.

a) How would this impact the competitiveness of US automotive firm General Motors competing with Japanese automotive firm Toyota in global markets?

b) How would the Bank of Japan implementing expansionary monetary policy impact the competitiveness of Toyota? How do you know?

c) Suppose the US government wants to, at a minimum, maintain its market share in the domestic automobile market, so they implement tariffs on cars imported from Japan. Illustrate and describe how such a policy will redistribute welfare within the US. Who gains and who loses? How does

this trade policy impact the volume of trade?