GSBA 549 The Firm in the National and International Economy

Final Examination
Marshall School of Business
University of Southern California

Name:

Honor System: You are to take this quiz under the conditions of the USC Marshall Honor Code. You may
not discuss this quiz with any current or prior student. Accessing prior year’s materials/quizzes is not
permitted. Your answers must be entirely your own. You are also obligated by the USC Marshall Honor
Code to report students who do not abide by its duties and expectations.

Time Allowed : 70 minutes

Exam Format : Part 1 – 30 multiple choice questions (30 points)

Part 2 – 4 short analysis question (20 points)

PART 1 – MULTIPLE CHOICE QUESTIONS (30 points)

Use the SCANTRON Form distributed in class to answer all of these questions. Please also mark your
choice on your test paper. If your selected answer on your test paper is not the same as your scantron
answer, your scantron answer decides your point.

(1 point each) Multiple Choice For each question, choose the statement that best answers the question
posed. Answer all questions.

1. Which of the following will increase the short run inflation?

a. Increase of aggregate demand.
b. Increase of money supply.
c. Increase of labor cost.
d. All of the above.

2. Suppose that the actual inflation rate turns out to be 2% lower than what you have expected, then,
a. you will earn 2% more than your expected real rate of interest when you lend your money.
b. you will pay 2% less than your expected real rate of interest when you borrow money.
c. you will make the same amount of real return as what you have expected when you lend your money.
d. you will pay the same amount of real rate of interest as what you have expected when you borrow.

3. Abenomics includes which one of the following?

a. Monetary easing.
b. Fiscal stimulus to the economy.
c. Structural reform of the Japanese economy to improve its total factor productivity.
d. All of the above.

4. Which one of the following is a possible explanation for the breakdown of the absolute purchasing power parity?
a. A Washington apple may be different from a Japanese apple.
b. Non-tradable goods invalidate the law of one price.
c. Tariffs and other trade restrictions prohibit cross border arbitrage.
d. All of the above.

5. “Ever-greening” in the case “Kinyuseisaku: Monetary Policy in Japan” refers to a phenomenon that
 a. Banks continue to extend new loans to failing companies.
b. Banks hoard excessive reserve.
c. Banks are not willing to lend to companies.
d. Banks continue to extend new loans to successful businesses.

6. From 2008 to the August of 2013, the monetary base in Japan doubled, but its CPI decreased from 102.1 to 100.3
(Exhibit 11 in the case Japan: Betting on Inflation). During this same period, Japan’s M2 only increased by 15.7%. What
could have been the reason for the small increase of M2 and the decrease of CPI?

a. Japanese banks were lending to firms and these firms were called Zombies.
b. Money going to the banking system stayed in the banks and did not make its way to businesses as loans.
c. Many Japanese were engaging the so-called carry-trade that borrowed Japanese Yen at zero interest rate and
invested in other currencies.
d. Bank of Japan was conducting quantitative easing, an unconventional monetary policy.
e. All of the above.

7. According to Ben Bernanke, the relatively low long term interest rate and high current account deficit of the U.S. from
2000 to 2007 can potentially be explained by
a. relatively high investment and high saving in the U.S.
b. relatively low saving and high investment in the developing nations.
c. relatively low investment and high saving in the developing nations.
d. None of the above.

8. China has a positive current account balance. Historically there are more private capitals moving into China than out of
China. The fact that China runs more or less a fixed exchange rate regime implies that
a. China’s central bank must be selling dollar assets.
b. China’s central bank must be selling its own currency to acquire foreign assets.
c. China is a net receiver of capital.
d. Both b) and c).

9. The Japanese current account surplus can best be attributed to

a. the high rate of Japanese domestic investment
b. Japanese protectionism
c. the high Japanese savings rate
d. government budget deficits

10. In Hong Kong, the currency, H$, is fixed against the U.S. dollar, at H$7.8/$, based on the currency board system. This implies
that
a. Hong Kong central bank cannot change its money supply at all because under the fixed exchange rate system, the central
bank does not have the monetary autonomy.
b. Hong Kong central bank can increase money supply anytime when the economy slows down.
c. Hong Kong central bank can only increase money supply by H$7.8 when its dollar reserve increases by $1.
d. Hong Kong central bank can only increase money supply by H$7.8 when its dollar reserve decreases by $1.

11. In a fixed exchange rate system with free capital mobility, the central bank
a. is always able to increase the money supply to stimulate the economy during a recession without causing problems.
b. will be difficult to increase the money supply to stimulate the economy during a recession.
c. will have to reduce the money supply if its foreign exchange reserves increase.
d. will have to increase the money supply if its foreign exchange reserves decrease.

12. According to the demand side of explanation (Keynesian), which one of the following is the main cause of economic
fluctuation?
a. Variations of the total factor productivity (or supply shocks).
 b. Fluctuation of capital stocks.
c. Fluctuation of aggregate demand.
d. Changing tastes of consumer.

13. The following diagram shows the behavior of Japanese yen and US dollar (Yen/$). Which of the following could be the
potential explanation for this behavior of the Japanese yen over the past forty years?

a. The Japanese central bank cannot adopt independent monetary policy.

b. Japan has been running large trade deficit during most of this thirty-year period.
c. The Japanese inflation has been higher than the US inflation.
d. The US inflation has been higher than the Japanese inflation.

14. According to the supply side of explanation (classical), which one of the following is the main cause of economic fluctuation?
a. Variations of the total factor productivity (or supply shocks).
b. Fluctuation of capital stocks.
c. Fluctuation of aggregate demand.
d. Changing tastes of consumer.

15. Some economists believe that an onetime tax rebate will not likely increase consumption because

a. an one time tax rebate does not affect much people’s permanent income which is a key factor for consumption
decision.
b. consumption depends on current rather than permanent income.
c. tax rebate does not change consumers’ current income.
d. All of the above.

16. During recessions,

a. Price generally increases.
b. Unemployment rate generally increases.
c. Interest rate generally increases.
d. Labor productivity generally increases.

17. Suppose that the current targeted federal funds rate is 5.5% and the market federal funds rate is 6.0%. Then the Federal
Reserve Bank will
a. buy some government bonds.
b. sell some government bonds.
c. increase the reserve requirement.
d. increase the discount rate.

18. Which of the following may result in the “savings glut” in 2005 described by Ben Bernanke?
a. Large increase of petroleum price led to rapid accumulation of wealth in oil producing countries.
b. Nations that suffered in the South East Asia crises were cautious in spending.
c. China’s wealth accumulation was very significant after entering the WTO.
d. All of the above.

19. According to a Keynesian policy maker,

a. monetary and fiscal policies are neither effective nor necessary.
 b. monetary and fiscal policies can deliver intended results in the short run.
c. monetary and fiscal policies can deliver intended results in the long run.
d. only policies that improve total factor productivities are effective in the short run.

20. Suppose there are only two countries, A and B, in the world. The world interest rate will be determined when (CA A,
KAA are current account balance and capital account balance of country A)

a. CAA + KAA = 0.
b. CAB + KAB = 0.
c. CAA + CAB = 0.
d. CAA + KAA = 0, and CAB + KAB = 0.

21. The excess reserve of the U.S. banks increased substantially after 2008. This is because

a. The interest rate is so low and money is so cheap.

b. The Federal Reserve Bank offers interest payment on commercial banks’ deposit at the FED.
c. Banks were worried about the risks of lending and there were more regulatory restrictions on lending.
d. All the above.

22. Which one of the followings can be regarded as a benefit of the fixed exchange rate system?
a. In a fixed exchange rate system, the government can increase or decrease money supply to counter fluctuation of
output and thus can smooth out the business cycles.
b. In a fixed exchange rate system, the central bank does not need to maintain adequate foreign exchange reserves.
c. In a fixed exchange rate system, the government is effectively barred from using monetary policy to achieve
its political goals so that price stability will not be sacrificed.
d. In a fixed exchange rate system, the government can set the exchange rate at a level that is more consistent with the
economic development and therefore prevents speculators from manipulating the foreign currency market.

23. During the financial crisis of 2008, the U.S. economy was in recession and the Federal Reserve Bank launched QE (quantative
easing). However, the U.S. dollar appreciated instead against Euro. This is because

a. The European economy was in a worse situation and its QE was even more aggressive.
b. The U.S. dollar is the world reserve currency.
c. The U.S. government wanted a strong dollar to bring confidence to investors.
d. All of the above

24. Some argue that digital currencies as currently designed with a pre-determined path towards a fixed eventual supply are
unlikely to achieve widespread usage in the long run. Their reasons include

a. that the values of these digital currencies are likely to increase which makes people less likely to use them as a
medium of exchange, if people believe that there is a market for digital currency.
b. that as few people are using these digital currencies as a medium of exchange, few merchants are willing to use
them as units of account.
c. that a fixed eventual supply could contribute to deflation in the prices of goods and services, and in wages.
d. All of the above.

25. The U.S. can be regarded as an area of single currency (US$). This common currency area is stronger than the common
currency area of Europe (Euro), the Euro Zone. The reason is
a. that the same language, culture and flexible labor market allow faster adjustment within the U.S. than the Euro
Zone.
that a strong federal government in the U.S. can help any state in trouble with federal-funded income transfer.
b. that the U.S. has a strong national financial structure, such as FDIC and Federal Reserve, to halt contagion.
c. All of the above.
26. The Third Arrow of Abe mainly includes policies to
a. Increase money supply.
b. Implement fiscal policy.
c. Increase Japan’s aggregate demand.
d. Increase Japan’s aggregate supply.

27. Since September 2012, the Japanese Yen decreased value significantly against $ and other major currencies. Which one
of the following could be a possible explanation for this?
a. The new Japanese (Abe Shinzo) government’s tough stance against deflation and potential territorial conflict
with China.
b. The U.S. potential third round of QE.
c. The Japanese economy showed sign of economic expansion.
d. All of the above .

28. Which one of the following may indicate that the Argentine Peso was probably over-valued before the 2001-2002 crisis?
a. Argentine current account balance was in deficit through most of its currency board system.
b. Capital flight was a serious issue.
c. As Brazil devalued its Real, Argentina experienced deflation.
d. All of the above.

29. Which one of the following is an argument against using the government spending to stimulate aggregate demand?

a. The government spending needs to be financed by tax either today or in the future; both may have a negative
impact on aggregate demand.
b. Policy makers may not have sufficient information to apply stimulus to achieve their goal and there are often
long lags before policies to be implemented and to take an effect.
c. Stimulus policies may often be used by politicians to favor their interest groups.
d. All of the above.

30. Which one of the followings is regarded as an advantage of the flexible exchange rate system?

a. The exchange rate more or less reflects the market demand and supply conditions.
b. There is a need for the central bank to keep foreign exchange reserves.
c. The central bank is not able to use monetary policy if necessary, when capital control is absent.
d. All of the above.
PART 2 – SHORT ANSWER QUESTIONS (20 points)

Your answers need to be as complete and concise as possible. Incomplete answers or irrelevant statements may result
some points deducted.

1. Euro can be regarded as a fixed exchange rate arrangement. In such an arrangement, one can think of the Greek
Euro is pegged against German Euro at one to one ratio. What are the benefits and costs to Greece when pegging
Greek Euro against German Euro?

Benefits of such an arrangement:

- By pegging against the currency (German Euro) of a low inflation country (Germany), Greece also has a low
inflation (Greece effectively imports low inflation from Germany).
- (minor point) Business transaction costs are lower for Greece

Costs of such an arrangement:

- By pegging against German Euro, Greece effectively gives up its monetary autonomy. It can no longer use the
monetary policy to stimulate the economy when its economy is in recession.
- This one-to-one exchange rate may not be the equilibrium rate. When Greece adopted Euro, investors rushed in
with the belief of eventual convergence between Greece with other richer European nations. Labor costs rose,
but labor productivity didn’t rise accordingly. This led to the loss of competitiveness of Greek products. Greek
Euro became overvalued. This worsened Greek current account balance. Government generous social welfare
spending (expansionary fiscal policy) and imprudent bank lending did not help Greek Euro either.
- As its current account worsened, Greece was increasingly relying on foreign borrowing (CA + PKA = 0).
Greece was not able to devalue its Greek Euro to halt the loss of competitiveness. The situation became risky.
When Greece entered into recession, investors rushed out. Such an arrangement could result in crisis
(CA+PKA = 0, you cannot have both terms negative. When private capital fled Greece, Germany or EU needed
to make up the difference to make the equation balanced.).

2. (5 points) Venezuela annual inflation rate in 2015 reached over 140% according its central bank. The following
figure shows Venezuela’s inflation rate in the last five years. The IMF estimates that its actual inflation rate was in
fact 275%, and will likely reach 720% in 2016.
a. What could be the reason for such a high inflation rate in Venezuela?

Answer:
Excessive money supply

b. The IMF believes that Venezuela is heading toward economic disaster. Pervasive shortages of consumer
goods and medicines are reported. Suppose hypothetically that the Venezuela government decides to solve
the inflation problem by adopting a currency board system. What would likely happen to its GDP growth
rate and unemployment?

Answer:
If Venezuela can strickly follow the currency board system, its money supply will be drastically reduced and
liquidity will be dried out. Its GDP growth rate will likely turn to very negative (a severe recession) and
unemployment will soar.

c. In contrast to Venezuela, several developed countries, like Japan, are troubled with potential deflation.
Some argue that deflation is more costly than inflation. Why so?

Answer (any two of the following):

o Wage may be downward sticky so deflation is likely to increase the real labor cost to businesses. This will
exacerbate unemployment situation, which further depresses aggregate demand.
o Normally the nominal interest rate cannot be negative. Deflation increases the real debt cost (r = i –
inflation). A country with many firms in debt may face a more serious debt problem.
o Deflation may deter household consumption decision as consumers wait for lower prices. This may further
exacerbate inadequate demand and thus worsen recession.
 3. (5 points) According to Case “Kinyuseisaku: Monetary Policy in Japan (A),” Bank of Japan was seriously
considering to increase the interest rate in October, 2007. In the following, mark Y, if you think that it is an
argument to support an interest rate hike; mark N, if you think that it is not.

a. Current Japanese interest rate at 0.5% made monetary policy hard to implement _____Y

b. Carry-traders caused large outflow of capital _____Y

c. CPI inflation was low and close to negative _____N

d. Weak economy abroad and potential financial crisis in the U.S.

_____N

e. Bank of Japan needed to avoid the perception of not being independent from politics _____Y

4. (5 points) Economists have different explanations of what causes recessions. Different explanations lead to different
policy prescriptions.

a. According to demand side economists (Keynesians), what is the major factor causing recession?

Insufficiant aggregate demand causes recession according to Keynesians

b. According to Keynesian economists, how can the central bank use the open market operation to counter recession?

Open market purchase of government bonds will increase the monetary base. Through the multiplier effect, more monetary
base leads to more money supply (M1, M2 or M3, etc.). Assuming price is sticky (a Keynesian assumption), this means more
real money supply. This will lead lower short term interest rate. Long term rate may thus be lowered if the yield curve more
or less shifts in a parallel fashion. As long term rate is lowered, consumption and investment increase, which lead to the
increase of aggregate demand.

c. Give one example that monetary policy via open market operation in your answer (b) may fail to achieve the goal of
countering recession.

Any one of these:

- The money multiplier may decrease so that an increase of monetary base does not necessarily increase money
supply
- Price may not be sticky
- Yield curve may not shift in a parallel fashion
- Consumption and investment may not be responsive to the long term rate