EC 208 – Spring 2022 25/03/2022

Murat Koyuncu
PROBLEM SET 2
(Due Date: 23:55 on April 3rd for Turnitin, +15 minutes for the email)
IMPORTANT REMINDERS:
1) Make sure you use your own words in your answers, any copy-paste’s from the lecture notes or
any other source will get zero and will be subject to further action regarding unethical conduct.
2) Answers to Part A should be hand-written, while the answers to Part B must be typed with a
word processor (see the explanations in each part). When done, name the scanned Part A as
‘Your Student ID_Hw2PartA’ and name the Part B file as ‘Your Student ID_Hw2PartB’, then
email them together to ec208homeworks@gmail.com with subject ‘Your Name – Your
Student ID – HW2’. Also, upload Part B to the Turnitin assignment 2 on Moodle. (These two
Part B’s should be exactly the same!).

Part A. Please answer questions in this part by writing down on a paper (Do not type on a
computer!) Then take a picture of your answers or scan the page(s) to convert them into
electronic form (PS: There are many free scanner apps for that job). Remember to have
verbal explanations of the mechanisms at play in addition to your graphical analysis!

A1. a) What are the current levels of the required reserve ratios on short run (1-3 months) TL
deposits in Turkey? (Hint: In Turkish, this is ‘Zorunlu Karşılık Oranları’. You should look up the
term first if you do not know its meaning.)

b) Suppose the CBRT changes the current RRR on all short run (up to 1-year maturity)
deposits to 10 percent. What does this mean for the TL money supply level i.e. does this
change increase or decrease the money supply? Explain briefly.

c) Using the asset approach, analyze the effects of the change in part b) on the USD-TL
Exchange rate, ETL/$, graphically and verbally, in the short run and assuming it is perceived
as a temporary change.

d) Now suppose that the CBRT president announced that the new level of RRR will be
permanent, analyze what happens to ETL/$ in the short run and the in the long run. Please
explain the mechanism.

e) Was there any overshooting or undershooting in part d? Explain why/why not.

A2. Imagine that the following events occurred in the period between 2000 and 2020.

 EU adopted new trade restrictions (such as higher tariffs) on Chinese products and
simultaneously reduced the annual rate of growth of their money supply from 5%
to 3%.
 Over the same period of time, Chinese real GDP, trade policies and the Chinese
money supply remained stable, so was the EU’s real GDP.

Seeing these as long run events, analyze the effects on the Euro-Yuan nominal exchange rate,
ECN¥/€, by using the extended version of the monetary approach (i.e. the PPP based model
with the real exchange rate extension).

A3. In Brazil, a recently introduced digital payment system, called Pix, has enabled
individuals to pay the merchants quickly and at zero cost via QR codes. This system has
been quickly adopted by over a 100 million people, reducing their demand for cash 1.

a) Assuming that this was a temporary shock, analyze the short run results of this
innovation on the Brazilian output and the ER$/Euro graphically (assuming there is no
policy response) using the AA-DD model. Explain the mechanisms verbally
b) What should the government of Brazil do to stabilize the output at its short run level
before the innovation occurred? Explain graphically and verbally

PART B. Answers should be typed up in this part and uploaded to the Turnitin assignment
we created on Moodle. You should also email both parts to us per our instructions above.

B1. Do not use any formulas in your answer to this question! Suppose Lebanese inflation
rate is high (~50 percent over one year), and the inflation rate in EU is low. According to the
relative PPP, what should happen over the year to the Lebanese pound’s ER against the
Euro? Make sure you use only words in your answer, and explain what purchasing power
parity is. What is the difference between its absolute and relative versions?

B2. Explain why the Economist magazine decided to improve its Big Mac Index by
incorporating differences in standards of living across countries. In your answer, explain
what Big Mac index is and how one can use this index to measure how over- or under-
valuation of a currency.

1
Please assume that we only use currency in circulation as the monetary asset in our model, so the basic deposit
accounts are not part of the money supply in this question.