FACULTE DES HAUTES ETUDES COMMERCIALES DE L'UNIVERSITE DE

LAUSANNE

Professor : Course : Session :

P. BACCHETTA International Money and Finance Summer 2017

J. ROULLEAU-PASDELOUP

• Documentation and calculator are not allowed

• 12 pages exam (except flyleaf) and a total of 120 points
• Write down your answers only in the space below each question

Surname and Name Student ID N° Place Number

Short Country Report (30%)

Exam (70%)

Final Grade

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Multiple choice questions (20 points) Circle the correct answer.
Questions 1 to 4 are worth 5 points per correct answer and -2 points per incorrect answer. If
the total number of points for questions 1 to 4 is negative, it will be counted with zero point.

1. People talked about “twin deficits” in the US economy in the 1980s. This means:

a. A combination of financial account and current account deficits

b. A combination of trade and current account deficits
c. A combination of fiscal and current account deficits

2. In the balance of payments, insurance payments are recorded

a. In the Balance of Secondary Income

b. In the Balance of Primary Income
c. In the Balance of Trade and Services

3. The Euro system can be described as a

a. soft peg.
b. hard peg.
c. managed floating.

4. What is the main driver of a second generation currency crisis?

a. Self-fulfilling prophecies.
b. A banking crisis.
c. Large primary deficits.
5. (5 points)
A Chinese citizen goes on a trip in Switzerland worth 3000CHF. He uses a check written on a
Chinese bank to finance his Swiss holidays (to buy the 3000 Swiss Francs). Record this
transaction in the Swiss Balance of Payments.

6. (15 points)
In class we have seen the following interest parity:
*
𝑖" = 𝑖"∗ + ∆𝑠"() − 𝑅𝑃"

a) Assuming agents have mean-variance preferences, as seen in class, what is the expression
for 𝑅𝑃" ? (6 points)
b) Describe the factors that influence 𝑅𝑃" ? (4 points)

c) It is often claimed that the expected excess return is equal to the risk premium. How can
you relate this claim to the above equation? (5 points)
7. (20 points)
Consider the figure below, which has been discussed several times in class:

a) What variable does this figure represent? (5 points)

b) We observe that these variables decline to zero between 1993 and 2000. Explain why. (5
points)
c) We observe that these variables increase again after 2008. Explain why. How does your
answer differ from b) (5 points)

d) We observe that these variables peak in 2012. How can you explain this rapid up and down
movement (based on what we have seen in class)? (5 points)
8. (10 points)
We saw in class that a currency crisis could be explained by a maturity mismatch in the
financial sector. Explain the mechanism.

9. (5 points)
According to recent empirical evidence, what are the effects of austerity policies in a
recession? Explain.
10. (5 points)
What does the impossible trinity say? Draw a beautiful triangle and explain.

11. (40 points)

Take the model with a soft peg and low capital mobility. We will analyze the impact of tax
shocks. The model is given by the following set of equations:

Where M is the level of money supply, BC is the amount of government bonds bought by the
Central Bank, S is the nominal exchange rate and FC* is the amount of foreign exchange
reserves held by the Central Bank. R is the domestic nominal interest rate, Y is real income
and P is the Price level. B is the total supply of bonds, H is a function that is increasing in R
and decreasing with R*, it is the share of bonds that is devoted to domestic bonds.
WP (resp. WF) is total wealth inherited from the past for domestic (resp. foreign) residents.
The φ function represents the share of domestic absorption spent on domestic goods, G is
domestic government spending and θ is a shock that only has effects on exports. In a soft peg,
we have r = R.
a) The third equation is the bond market equilibrium. Explain how one can derive from it a
relationship between Y and R. Draw the latter (BB curve) in a R-Y diagram. (7 points)

b) The fourth equation is the goods market equilibrium. Explain how one can derive from it a
relationship between Y and R. Draw the latter (GM curve) in a R-Y diagram. (7 points)
c) Assume that the Government wants to increase taxes (i.e, T increases). Explain which
curves are going to be affected, and how. Represent graphically and discuss the new
equilibrium. (8 points)
d) Does this generate capital inflows or outflows? Represent the MM curve before and after
the shock. Explain. (8 points)
e) Now use only the BB and GM curves and assume that the government increases its taxes
(i.e, T increases) while the economy is at the zero lower bound. Explain which curves are
going to be affected, and how. Represent graphically and discuss the new equilibrium. Are the
effects bigger than in normal times? Why? (10 points)