Econ 490 – Final Exam PDF

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Econ 490 – Final Exam...

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Econ 490 – Final Exam Short Answer 1. The coronavirus, state-wide lockdowns, and travel restrictions have paralyzed global trade, contributing to trade deficits. The “massive” nature can be attributed to the fact that China has been hammered with import taxes, US consumers spend more than they produce, and coronavirus has collapsed global activity. The shortfalls of trade deficits can be made up for by borrowing money from foreign leaders of permitting foreign investment, which is a source of long-term economic growth if the money is invested in productivity growth. Arguments for the trade deficit include greater foreign direct investment, greater financing of federal deficit and debt, and increased ownership of stock. On the other hand, unemployment is rising in the US and increasing imports will contribute to additional job loss for US citizens. Also, large trade deficits increase foreign investors’ stress about repayment and cause them to pull money out of the countries, negatively impacting them. 2. Assuming there was only a risk-free bond that paid 0% interest, there would be no valuation changes. Thus, the NIIP for 2017 would be 36 billion. The NIIP would be higher in the real world because US investors have a tendency to hold riskier assets with higher returns abroad, resulting in them making more money with lots of variation. The US is noted to earn more investment income on foreign assets than foreign investors earn on their US assets, resulting in a higher NIIP. 3. Assuming the US has a higher GDP per capita, the expected costs would be lower than those of the other country. A higher GDP per capita is an indicator of the total income generated by economic activity in a country, thus being a measure of citizen’s material well-being. Higher GDP means there is higher income of the government and more funds available to spend on healthcare. A higher GDP per capita suggests a smaller population comparatively and less money needs to be invested due to the lower population. 4. If both countries hit their target inflation rates, the nominal exchange rate would increase over the next 20 years and the home currency would appreciate in comparison to the

foreign currency. Inflation is able to offset any changes in nominal exchange rate but only in the long-term because prices are sticky in the short-term. In this scenario, the targeted inflation rate is lower than current inflation, so the purchasing power parity would decrease and thus, the exchange rate would increase. 5. False; While GDP is a good indicator of economic welfare because it measures consumption, investment, net trade, and expenditures, it is not sufficient to estimate the costs of the pandemic. Each country is impacted differently by the virus, each country has a different GDP and each GDP is impacted differently so an overall estimation would not be correct. While physical capital is captured, there is also economic downturn from human and natural capital that is not included in the measures. 6. If wages are sticky and the nominal exchange rate is pegged, I would anticipate the consumption to decrease and unemployment to not change. Since wages are stagnant and price level is not, consumers will have decreased purchasing power and the result will be a decrease in their consumption. This will increase their precautionary savings. By fixing the exchange rate, countries are forfeiting control of their monetary policy and tying their currency to that of another country’s currency or the price of gold. Since monetary policy has not impact on the exchange rate, unemployment will stay the same. 7. True; The stimulus package will provide lower-income consumers with temporary funds, increasing their purchasing power. This will encourage spending and investment by the consumers, decreasing savings, and increasing interest rates. 8. Considering it is any given Monday, there are two possible equilibrium to this model. Either everyone will want to stock up on toilet paper and will participate in the lottery. The have a greater incentive to hold extra toilet paper in this scenario and will participate in the random drawing for the possibility of gaining additional roles. The other equilibrium is that no one visits the grocery store for toilet paper. Their likelihood of needing a new roll is low and they have no incentive to deviate. 9. During the amidst crisis, the largest tension among businesses has been the lack of liquidity. With low sales and few customers, cash inflow and outflow has been minimal.

To combat this lack of liquidity, the government initially offered a stimulus package and has now begun to offer loans to businesses. Their hope if the on-hand funds will boost the economy, increase consumption, and attempt to normalize the markets. 10. The lack of liquidity and loss of employment due to the crises are the main factors behind such activities. Many US citizens have no availability of funds due to the temporary shutdown of many businesses. This leaves Americans with little to no money to pay for housing. This is worrisome for the economy as a whole because so many people facing the same issues causes tension to arise concerning the future of these families and businesses. The lack of progress of the pandemic suggests this plight is not improving anytime soon and Americans have little ability now to control the cash movement in the economy due to lack of liquidity. 11.

The coronavirus bonds, AKA perpetual bonds, have been requested by Italy to

fight the pandemic that has taken a massive human and economic toll. The advantages of these bonds are that they never need to be repaid, so they impose a light fiscal burden on the EU and interest payments on them would be a very low fraction of the EU’s budget. These bonds would also be an attractive asset to purchase because their maturity is always the same and no portfolios need to be rebalanced. They would also allow suffering countries to raise enough debt to cover any economic damages they are incurring. These bonds would help the recovery of respective country’s economies and thus help the power of the euro. 12.

According to the optimal currency area theory, there are specific areas that are not

bounded by national borders that would benefit from a common currency. Thus, it is feasible for currency unions to be located in areas that they will most likely be used. Currency unions are most feasible in geographic regions that benefit from utilizing the same currency, causing them to be organized geographically. 13. The US dollar is the world’s reserve currency, so as the world economy became riskier, the investors began to gravitate towards greenbacks. This can be attributed to the fact that the dollar can be used as a mechanism of power abroad and due to income inequality. The growing income inequality in many other countries increases the demand for savings, a majority of which is in foreign assets (like the dollar). When comparing the dollar

to other currencies like the euro, the Eurozone governments creates many debt securities so not all bonds are the same, unlike in the US where all treasury bonds are equal. This makes US bonds relatively less expensive and safer investment options for foreigners. 14. Central banks in countries hold safe assets for reserves and to manage interest and exchange rates. An increase in the demand/holding of safe assets results in interest rates being lowered. Since the government has been able to maintain a stable fiscal policy and stable inflation, other countries are now interested in holding China’s safe assets, which allows China to borrow from the rest of the world cheaply, resulting in lower interest rates.

Currency Unions

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