Problem Set 4 - International Economics S2022

Problem  1.  Read the article ”Ukraine war piles pressure on Europe’s farmers” (Financial Times, 3  April, 2022) available on Brightspace. Mention and explain the ”four F’s”crisis that European farmers  are facing as a consequence of the war in Ukraine. What is the possible impact in European countries’ current account?

Problem  2.  Answer the following questions briefly.

a) What items are excluded from the calculation of GDP?

b) Explain how it is possible for the United States current account deficit to grow while the budget deficit has disappeared, as happened in the 1990s.

c) Is it possible for each nation to have CA surpluses? Explain.

d) How are GDP and domestic spending related in a closed economy? In an open economy?

Problem  3.  Real and nominal GDP.

Table 1: France’s production

a) Why is it important to adjust nominal GDP for price changes?

b) Imagine France’s economy only produces and consumes cheese and wine at prices and quantities shown in the tables above. Calculate France’s GDP for 2020 and 2021 at current prices (nominal GDP).

c) Calculate France’s GDP at constant prices when 2020 is the base year (real GDP). What is France’s nominal and real GDP growth rate? Explain the differences.

Problem  4.  Balance of Payments.  The table below is a summary of the balance of payments of Flo- rentonia.

a) Recover the missing entries, indicated with ”???”. Explain how you compute them. (Hint: Carefully read page 301 of Sawyer  Sprinkle where they explain that the item ”Net Acquisition of Financial Assets” enters with opposite sign - similar to ”Financial Derivatives, net”.)

b) Consider the balance of payments of Florentonia.  For each of the following transactions describe both entries into the appropriate category of the balance of payments (be specific for the Current account referring to the categories above). For each transaction, say whether the current account is affected.

i) The PaperPencil company in Florentonia pays $ 100 in salary to an employee who is a citizen of Londratonia.

ii) A foreigner buys a share of the PaperPencil company incorporated in Florentonia worth $ 10.

iii) The central bank of Florentonia buys government bonds of Londratonia worth $ 200.

iv) The PaperPencil corporation buys tables for its offices from a firm located in Londratonia and pays $ 1100.

v) After a pandemic affects Florentonia, the government of Londratonia sends $2,000 worth of medical aid.

Problem  5.  Japan has run large current account surpluses for much of the past two decades, yet no one ever asks if these surpluses are sustainable. Why are surpluses treated differently than deficits?

Problem  6.  Exchange rates.

Figure 1: Exchange Rates. Source: retrieved from FRED

a) Given the information in Figure 1, did the Turkish Lira depreciate or appreciate from the Turkish perspective between January 2020 and January 2021?  Explain.  In the right–hand side we allow for a comparison relative to the EUR/USD exchange rate where both have been converted into an index (2015 = 100). What can you say about the volatility of the Lira?

b) A pistachio baklava in Turkey costs 2.5 Lira at the beginning of January 2020 and assume first its price does not change throughout 2020.  How many baklava would a U.S. tourist visiting Turkey be able to buy with $60 on the 3rd of January 2020 compared to the 1st of January 2021?  Is the baklava becoming more or less expensive in dollar terms? Research now what inflation was in

Turkey in 2020 and calculate what the baklava’s price likely was at the beginning of January 2021. How does your answer to the previous question change?

c) Plot the demand curve for Lira in terms of USD (think of the amount of Lira the US tourist is demanding in the baklava example at the two exchange rates).  What happens to the demand curve if U.S. income has risen and the tourist now has $70 to spend on baklava in Turkey?  (No calculations needed, provide a graphical argument for full credit.) Can you predict if the Lira will appreciate or depreciate relative to the dollar?  Would your answer change if income in Turkey increases by the same percentage as well?

Problem  7.  Assume that you are a US investor who has available $100,000,000 to invest for six months, and that the six-month interest rate is 5% in the US. In addition you know that the six-month interest rate in Italy is 4%. You also observe the following quotations: spot exchange rate USD 0.99 per 1 EUR and a six-month forward rate USD 1.01 per 1 EUR. Where should you invest to maximize the return of your investment? Explain the role of the appreciation/depreciation of the dollar in your answer. Is this forward rate an equilibrium rate?

Let’s consider that you are the manager of a multinational corporation that is not willing to be exposed to currency risk: what forward rate would be the equilibrium rate that covers against currency risk, given the same spot and interest rates?