Economics 103 — Spring 2011International Monetary RelationsProblem Set 1March 31, 2011Due: Fri, April 22, before 12:30pmLocation: Econ 113Instructor: Marc-Andreas MuendlerE-mail: [email protected] Finance and Trade Perspectives on the Cur-rent AccountCurrent account imbalances can be interpreted with a perspective on commoditytrade or on financial transactions. For our purposes, CA = EX − IM. Usingthe result that S = SP+ SG= I + CA, show that CA = SP− I + (T − G) isalso true.• Since 2003, Singapore is running both a fiscal surplus and a current ac-count surplus. Use suitable interpretations of the current account to ex-plain how one could give rise to the other. Converting Singapore’s fiscalsurplus into USD, infer the difference between private savings and invest-ment in Singapore for 2003, 2004 and 2005.• Ireland exhibits considerably smaller GNI than GDP. Infer the differencein Euros for the years 1999 through 2004. Which of the two series growsfaster? What explains this difference? Can you infer whether foreignersor domestic residents raised their incomes faster?• During the 1990s, private household debt in the United States has beengrowing at a faster rate than US economic output, while the ratio ofhousehold debt to equity rose from 84% to 105% between 1990 and 2000.At the same time, government deficits prevailed except for a short periodin the late 1990s. Do you think raising tariffs would have reduced thevalue of US net imports? Would tariffs have reduced the volume of netimports?Data. Visit http://www.imfstatistics.org/imf/ and obtain the current ac-count surplus and fiscal surplus for Singapore in 2003, 2004 and 2005. Forthis purpose, click the “options” button at the top and then click on the “con-straints” icon. Delete the default country (the United States) by clicking onthe minus sign and then add Singapore by highlighting Singapore and clickingthe “Save” button. Next, close the constraints window, click on the “Browse”button and then select “Country Tables” in the upper left-hand box. SelectSingapore and then click on the box next to the series “Current Account, n.i.e.”(series code: 57678ALDZF...), “Cash Surplus/Deficit [1-2-31=1-2M]” (seriescode: 576cCSD.BA...) and also “Market Rate” (series code: 576..RF.ZF...).1Then, click the “+” button at the top to add the series, close the pop-up indi-cating the series you have selected, and then click “retrieve”. This facility willallow you to download the series directly into a spreadsheet file. Repeat similarsteps for the according series for Ireland.2 An N -country WorldThink of a world with N countries, each with its own currency. How manybilateral exchange rates are there? (You may try working your way up fromn = 1, 2, ... to n = N.) How many current accounts can clear independently?So, how many independent exchange rates can there be?In this light, how would you characterize the dollar under the Bretton Woodssystem? Does this characterization help explain the external balance problemof the United States and the Triffin Dilemma? Why or why not?3 Spread of the Great DepressionAbout a third of all US banks failed during the onset of the Great Depressionbetween 1929 and 1933, wiping out around a quarter of the US money in cir-culation (M1). Most major economies were back on a gold standard by thattime. If the central banks in those countries adhered to the rules of the game,how would the monetary contraction in one country spread to other countries?If central banks did not adhere to the rules of the game, what would be thecurrent account response under the price-specie-flow mechanism?4 The Transfer ProblemThink of a world with two countries D and R under a fixed exchange rate regime.(You may consider an international gold standard, for instance, where the price-specie-flow mechanism is at work.) Country D (donor) surprisingly transfersincome Y (not gold) to country R (recipient). Examples of such transfers aresharp increases in oil prices and subsequent income transfers to oil exporters,foreign aid, or war reparations.What is the likely current account response after the transfer? There are twocases that caused much controversy: (i) As Keynes stressed, R may try to usethe transfer to consume mostly domestic goods. (ii) As Ohlin countered, R maytry to use the transfer to demand mostly imports from D. Does the distinctionmatter for the value of the current account response? Does the distinctionmatter for the trade volume response?Hint. To determine the current account value, consider what the incometransfer means for savings and investment.25 Theory and Empirics of Interest ParityState the uncovered and the covered interest parity conditions.1. Why is uncovered interest parity called uncovered? Does it have to hold?What assumptions are needed? How does it compare to covered interestparity?2. The USD 3-month deposit (interest) rate and the GBP 3-month depositrate are both 5.0%. What is the relationship between the current equi-librium USD/GBP exchange rate and its expected future level? Assumethe expected USD/GBP exchange rate three months into the future re-mains constant at USD 1.50 per GBP. But the GBP 3-month deposit ratedoubles to 10.0%. What is the new spot USD/GBP exchange rate inequilibrium?3. Plot the difference between the USA 3-Month Certificate Of Deposit Rateand the UK 3-month Sterling Time Deposit Rate from January 1, 2001 toMarch 31, 2010. What do you observe? Now plot the expected exchangerate change (Ee− E)/E at the three month horizon for the USD/GBPexchange rate, assuming that investors have perfect foresight so that theexpected exchange rate equals the future realized spot rate. Does Uncov-ered Interest Parity seem to be satisfied in the data? Describe the stepsyou would have to take to check for covered interest parity in the data.You may choose not to print the graphs. In that case, draw the stylizedfigures for your answer.Data. Visit https://www.globalfinancialdata.com/ and display graphs onyour screen (using monthly frequency for 2001-2010) with the UK 3-monthSterling Time Deposit Rate (symbol: ICGBR3D), the USA 3-Month Cer-tificate Of Deposit Rate (symbol: ICUSAT3D), the USD/GBP exchangerate (symbol: GBP D). (You do not need the USD/GBP 3-month For-ward Rate (symbol: XRGBP3D) but may find it instructive to display.)To view a series, enter the according symbol in the “GFD file search” fieldin the upper left-hand corner. You may want to