Open Economy Macroeconomics — DU B.A. (Hons.) Economics Previous Year Question Papers

Open Economy Macro`economics Name of programme: Common Pool of DSE 3. Use of appropriate figures/diagrams are necessary 1. a. Consider an investor in the United States (US) with 1000 dollars to invest either in Califomia (US) or in London (United Kingdom). The one-year interest on investme`nts is 2% in UK and 4.04% in US. The one-year forward dollar-pound exchange rate is 1.575 dollar per pound, and the spot rate is 1.5 dollars per pound. Answer the following questions using the Uncovered Interest Parity and Covered Interest Parity conditions: i. What is the (riskless) dollar-denominated return on British deposits for this investor using forward cover? ii. Is there an arbitrage opportunity here? Explain why or why not. iii. If the spot rate is 1.5 dollars per pound, and interest rates are as stated previously, what is the equilibrium forward rate, according to covered interest parity (CIP)? iv. If uncovered interest parity (UIP) holds, what is the expected depreciation of the Dollar (against the Pound) over one year? b. What are tfie-f6reign exchange derivatives? Discuss any three. c. "In countries that cannot borrow in their own currency, floating exchange rates are less useful as a stabilization tool and may be destabilizing". Elucidate. a. Using simple money market conditions derive the fundamental equation of the monetary approach to the exchange rate. In the process, also determine which factors affect the exchange rate and how? b. Illustrates the path of the key variables followed by an increase in the growth rate of the money supply in the General (Standard) Model of monetary approach to exchange rates. a. As per the unified approach to the exchange rates (i.e. complete theory of floating exchange rates), the permanent money supply expansion has a much greater impact on the exchange rate in the short run as compared to the long run. Elaborate on this, "Exchange Rate Overshooting", with suitable fig.ures. b. If a country wants to fixed (pegged) the exchange rate, then it has to sacrifice its monetary policy autonomy both in the short-run and the long-run. Illustrate with a suitable example. a. A temporary flscal expansion that increases government spending increases output dramatically under the fixed exchange rate regime, while the interest rate and exchange rate are left unchanged. Elucidate with a suitable figure. b. What is the liability dollarisation? What are the implications of exchange rate depreciation on national wealth and aggregate demand if foreign currency liabilities exceed foreign currency assets? 5. a. Examine the model of exchange rate crisis due to inconsistent fiscal policies with the investor's perfect foresight. Does it explain why fixed (pegged) exchange rates sometimes witness a collapse rather than a long, lingering death?