Professional Documents
Culture Documents
HE206
NANYANG TECHNOLOGICAL UNIVERSITY
April 2009
INSTRUCTIONS
1
Begin your answer to each question on a separate page of the answer book.
SECTION A
Question 1
Consider a small open economy with a flexible exchange rate system and free capital
mobility. Suppose the economy is best described by the following DDAA framework:
AA curve:
DD curve:
M/P = L (R*+Ee/E-1, Y)
Y = Y (EP*/P, A0)
where the AA curve represents asset market equilibrium and the DD curve represents goods
market equilibrium, M is domestic money supply, P is domestic price level, R* is world
interest rate, E is the exchange rate (i.e., domestic currency per unit of foreign currency), Ee
the expected value of E, Y is domestic output, L(.) is the domestic real money demand
function, L1 and L2 are the first and second derivatives of the L(.) function, P* is foreign price
level, A0 is the term containing all autonomous expenditures, Y(.) is a function related to
aggregate demand, and Y1, and Y2 are the first and second derivatives of the Y(.) function.
ATTENTION: The Singapore Copyright Act applies to the use of this document. Nanyang Technological University Library
HE206
Question 1 (continued)
(a)
Suppose price only adjusts gradually while exchange rate adjusts instantaneously.
Discuss the short run and long run effects of a permanent reduction in domestic
money supply on the exchange rate, output, price and interest rate.
(10 marks)
(b)
Now suppose price is perfectly flexible in the short run. What would be the short run
and long run effects of the permanent reduction in domestic money supply on the
exchange rate, output, price and interest rate?
(5 marks)
(c)
Use the modified monetary approach to discuss the long-run effect of each of the
following changes on the nominal and real exchange rates of the domestic economy:
(i)
A 20% rise in domestic money supply; and
(ii)
A rise in worlds demand for domestic product.
(10 marks)
(TOTAL: 25 marks)
Question 2
Consider a small open economy with a fixed exchange rate system and free mobility of
capital. Suppose domestic investment is now a negative function of domestic interest rate so
that the economy is best described by the following DDAA framework:
AA curve:
DD curve:
M/P = L (R*+Ee/E-1, Y)
Y = Y (EP*/P, R*+Ee/E-1, A0)
where the AA curve represents asset market equilibrium and the DD curve represents goods
market equilibrium, M is domestic money supply, P is domestic price level, R* is world
interest rate, E is the exchange rate (i.e., domestic currency per unit of foreign currency), Ee
the expected value of E, Y is domestic output, L(.) is the domestic real money demand
function, L1 and L2 are the first and second derivatives of the L(.) function, P* is foreign price
level, A0 is the term containing all autonomous expenditures, Y(.) is a function related to
aggregate demand, and Y1, Y2 and Y3 are the first, second and third derivatives of the Y(.)
function.
(a)
Suppose the economy is originally at its natural level of output Yn. Now consider a
permanent rise in world interest rate R*. Will the rise in R* cause a shift in the AA,
DD and/or Yn curves?
(5 marks)
ATTENTION: The Singapore Copyright Act applies to the use of this document. Nanyang Technological University Library
HE206
Question 2 (continued)
(b)
Suppose the economy is able to maintain the fixed exchange rate. What will be the
effect of the rise in R* on domestic output in the short run? Use also the money
market and foreign exchange market diagrams to discuss its impacts on domestic
interest rate and money supply in the short run.
(7 marks)
(c)
What will be its long run effect on domestic output, price, interest rate and money
supply?
(5 marks)
(d)
Suppose it takes more than five years for adjustment of price to restore the economy
back to the natural level of output, and the economy is not willing to wait for such a
long adjustment. What monetary and/or fiscal option(s) does the economy has?
(8 marks)
(TOTAL: 25 marks)
Question 3
(a)
Consider an economy that is best described by the Swan Diagram with the following
internal balance (IB) and external balance (EB) curves:
IB curve: Y = Y(EP*/P, A0, Y*)
EB curve: CA = CA(EP*/P, Y-T0, Y*)
where E is the exchange rate (i.e., domestic currency per unit of foreign currency), P*
is foreign price level, P is domestic price level, A0 is the term containing all
autonomous expenditures, Y* is world output, Y is domestic output, T0 is the
domestic lump sum tax, Y(.) is a function related to the internal balance, Y1, Y2 and
Y3 are the first, second and third derivatives of the Y(.) function, CA(.) is a function
related to the current account balance, and CA1, CA2 and CA3 are the first, second and
third derivatives of the CA(.) function.
(i)
Suppose there is a global recession. Will the internal balance curve and/or the
external balance curve be affected by this global recession?
(5 marks)
ATTENTION: The Singapore Copyright Act applies to the use of this document. Nanyang Technological University Library
HE206
Question 3 (continued)
(ii)
(iii)
(b)
Briefly explain why there could be a J-curve effect? Suppose a country just
devaluates its currency by 10%, use the J-curve effect discussion to trace the likely
changes in her current account balance in the short run and long run.
(10 marks)
(TOTAL: 25 marks)
Question 4
(a)
Briefly explain the restricted choices implied by the doctrine of Impossible Trinity.
What has Singapore chosen? Why? What has China chosen? Why?
(6 marks)
(b)
Briefly explain why Singapore has been persistently running a huge current account
surplus over the past two decades. If left unattended, this could have caused enormous
monetary growth pressure. How do Singapores CPF system and overseas investment
policy help to avoid the excessive monetary growth pressure? How do they affect
Singapores relative importance in the global economy?
(6 marks)
(c)
In recent years, China has also been running a huge current account surplus which has
contributed to the enormous monetary growth pressure in 2006-2007. With the
existing differences between Chinas and Singapores systems, explain to what extent
China can learn from the above Singapore experience. What other monetary policies
has China used to mitigate the monetary growth pressure?
(7 marks)
ATTENTION: The Singapore Copyright Act applies to the use of this document. Nanyang Technological University Library
HE206
Question 4 (continued)
(d)
Briefly describe Singapores exchange rate system under the normal circumstances
and under extreme economic adversity.
(6 marks)
(TOTAL: 25 marks)
SECTION B
Question 5
What are the similarities and the differences between the Latin American Debt Crisis of the
1980s, the Asian Financial Crisis of 1997-1998, and the US Subprime Mortgage Crisis of
2007? Discuss by focusing on the causes of the crises and the appropriate policy responses to
manage and resolve them.
(TOTAL: 25 marks)
Question 6
On the subject of reforming the international financial architecture, commendable progress
has been made in crisis prevention efforts and some progress has been achieved in crisis
management and resolution. However, very little progress has been made in reforming the
governance of the International Monetary Fund. Explain by giving examples of selected
reforms.
(TOTAL: 25 marks)
- END OF PAPER -