Homework Assignment #3 Chapters 11-14 ECON 321B

This homework assignment must be turned in before you will be authorized to take your first unit exam for Part II of the course.

Please note that this assignment requires several full essay answers, not just truncated or single-sentence answers. Some of these questions require you to think and bring together various models, concepts, evidence, and ideas from the textbook. By taking the time to think out these questions, you will gain a deeper understanding of the material covered in the textbook and the lectures.

1. Use the circular flow diagram to illustrate the following statement: In an economy, total lending must equal total borrowing. Does it matter whether you use a closed-economy circular flow diagram or an open-economy circular flow diagram?

2. Discuss and provide examples of how choices by individuals, firms, organizations, government agencies, etc. affect other parts of the economy. Specifically, discuss how these decisions affect the circular flow. What do the diverse motivations by individuals, firms, banks, etc. imply for the stability of the economic system?

3. The following items are from a hypothetical countrys balance of payments ($billions):a. Imports of services: $486b. Borrowing from private foreigners: $507c. Exports of goods: $823d. Net transfers: $51e. Exports of services: $428f. Private lending to foreigners: $443g. Imports of goods: $537h. Borrowing from foreign central banks: $5i. Increase in official reserve assets: $256

Assume that these payments include all of the countrys international payments. Place each item where it belongs in the current account or in the financial account, being sure to check that the sum of credits is equal to the sum of debits. Does the balance of payments balance? What are the current account and financial account balances?

4. You are given four of the exchange rates between U.S. dollars, Japanese yen, Argentinean pesos, Taiwanese dollars, and Turkish lira. Complete the grid by filling in all the blanks, assuming triangular arbitrage is complete:

US$ yenpesosT$lira

US$ per ___ ___ ___ ___ ___yen per 100 ___ ___ ___ ___ pesos per 2 ___ ___ ___ ___T$s per 25 ___ ___ ___ ___lira per 50 ___ ___ ___ ___

Complete the grid by filling in all the blanks.

5. Explain the carry trade. Is it a rational market? Why or why not? Explain.

6. Suppose that there are no restrictions on international asset transactions, and people are risk neutral. For each of the following cases, if the values for domestic and foreign interest rates and the expected future exchange rate are as given, find the spot exchange rate:a. r* = 10%, r = 5%, and Etet+1 = $1.00.b. r* = 5%, r = 10%, and Etet+1 = $1.00.c. r* = 5%, r = 5%, and Etet+1 = $1.00.

7. Explain what the presence of triangular arbitrage in the foreign exchange market means for each individual exchange rate.

8. Explain what the interest parity condition tells us about the spot exchange rate. (Hint: set up the interest parity condition, and move the spot rate to the left of the equation and everything else to the right-hand side of the equation.)

9. Explain what De Grauwe (1989) meant when he described exchange rates as near-rational. How does De Grauwes thinking relate to that of John Maynard Keynes, who described the role of convention in determining market prices under uncertainty.

10. Explain Hyman Minskys financial instability hypothesis. Be sure to present his step by step derivation of his conclusion, detailing the ideas that he builds on.

11. It is well known that the United States in 2010 had a government primary budget deficit of8 percent, an economic growth rate of 1 percent, a real interest rate of zero percent, and a total debt of 100 percent of GDP. Is the U.S. budget deficit sustainable? (Hint: Use the analysis from the section en titled Tracing the Path of Public Sector Debt: An Example.)

12. Review the conditions of the Brady Plan. Was it a fair plan for all parties concerned?