International Economics Prof. Rivera-Batiz
BAU International University Spring 2018
Please answer all of the following four questions. This problem set is due February 14th (before class). Note that this problem set is to be answered individually, not by groups, although the solutions can be discussed and analyzed in small groups. The answers must be submitted as a hard copy.
- Suppose that the foreign exchange market for dollars in a small African country, X, can be represented by the following demand and supply equations:
QD = 15 – 3e
QS = 10 + 2e
where QD represents the quantity demanded of dollars by the private sector in the Country X’s foreign exchange market (measured in millions of dollars), e represents the exchange rate between the local currency, called the tajiri, and the dollar (expressed in tajiris per dollar), and QS denotes the quantity supplied of dollars by the private sector in country X’s foreign exchange market (measured in millions of dollars).
(A) Suppose that Country X and the US are under a system of flexible exchange rates. What would be the equilibrium exchange rate during the period of concern? How many dollars (in millions) would be traded during this period? Provide a numerical answer as well as a diagrammatic answer. Explain your answers.
(B) Suppose now that the government in Country X imposes a fixed exchange rate system, with the exchange rate set at 0.50 tajiris per dollar. Strict controls govern the foreign exchange market, and all transactions (purchases and sales of dollars) occur through the central bank. At the given exchange rate, would the central bank buy or sell dollars from the private sector and what would be the amount of dollars that the central bank of country X would buy from or sell to the private sector in each time period? Given this situation, what would you recommend country X’s central bank do in the future? Should it continue to fix the exchange rate or not? Why? Explain your answers.
- What do you think are the prospects for the Chinese yuan as an international currency (used by persons, companies and central banks in international transactions) as compared to the U.S. dollar? Do you think the yuan (renminbi) will replace the dollar as an international currency? Why or why not? Please support your answer with any research available on this issue.
- You are given the following data regarding money supply growth in 2016 for a range of countries. Please find, for the same year, 2016, the rate of inflation of consumer prices. Then, in a graph, plot the money supply growth in the horizontal axis and the inflation rate in the vertical axis. Is the relationship between money supply growth and inflation positive or negative? Why?
Country Money Supply Growth in 2016
United States 3.8%
South Sudan 142.7%
Definition of money supply used is broad money supply, as defined by the IMF.
- At the beginning of 2016, the economy of Venezuela had an interest rate (lending rate) of 20.8% while the equivalent interest rate in the United States was 3.5%. Using the uncovered interest parity condition, was the Venezuelan bolivar expected to depreciate or appreciate relative to the dollar during 2016? Explain your answer using the analysis of the uncovered interest parity condition discussed in class.