Applied International Macroeconomics

APPLIED INTERNATIONAL MACROECONOMICS

Spring 2018: Practice Problems 9

Due Wednesday, February 28, at the beginning of class

1. Please attach some item from the media related to a country intervening to influence its exchange rate, with a brief explanation of how it is related to class material.

“MOSCOW, Feb 3 (Reuters) - Russia will resume buying dollars next week for the first time since a brief burst in 2015, but sources told Reuters the purchases will go ahead only after a reluctant central bank won assurances it could distance itself from the operations.

The central bank, which has a policy of letting the rouble float freely, insists it is not intervening in the foreign exchange market to influence the currency’s rate. Instead, it said last month that it would merely buy the dollars on behalf of the finance ministry, which came up with the plan following a modest uptick in oil prices over the past year.” - Russian central bank seeks to keep dollar purchase plan at arm's length-sources

Comment: this piece of article related closely to our recent topic of Country interventions under inflation and exchange rate changes: the country will increase its H to support the home currency and weaken the home currency from selling and buying US dollars.

https://www.reuters.com/article/russia-cenbank-intervention/russian-central-bank-seeks-to-keep-dollar-purchase-plan-at-arms-length-sources-idUSL5N1FO2NZ

2.        As discussed in class, the mechanisms through which prices and exchange rates have been stabilized have changed as the world adopted different monetary systems. Notably, governments had little control over money supplies and exchange rates until the past century or so. You will construct examples showing that money supplies were endogenous under three different monetary systems.

i.  In medieval Europe, money – silver pennies – was often in short supply. Suppose Germany’s economy grew robustly but its supply of silver pennies did not.

        What would have happened to prices of goods and services in Germany?

As the Germany’s economy growth and the supply of sliver pennies being limited, the prices of goods an services in Germany will be higher.

        How would German trade with other countries have responded to this change in prices?

As the price of Germen’s items being more expensive, the German will import products and services from other Countries because of the lower prices and the export of local goods will decrease.

        How would the shift in trade have affected the supply of pennies in Germany?

Since the import increases and export decreases, German’s increasing spending to other Countries will the shift in trade and decrease supply of pennies in Germany.

ii.  Under the Gold Standard of the 1800s, countries began to use paper money. It was originally issued by private banks, which backed the notes with gold in their vaults.

Suppose the official parity between the German mark and gold was worth 2790 Mark = 1 kilogram of pure gold.

And suppose Germany’s economy grew robustly but its supply of gold did not.

        What would have happened to prices of goods and services in Germany?

Under Gold Standard, the economy growth will lead to an increasing price and service for this Country.

        What would have happened to the private price of gold in terms of marks?

The pricing of the goods increase, so the same amount of the marks will value less (German would need more gold to purchase compare to before), the private price of gold in terms of marks will increase. In another word, Germany’s goods become more expensive than foreign goods.

        How could a speculator in another country have made money by arbitrage?

A speculator in another country will export goods to Germany with the price advantages and receive gold from Germany.

        How would this arbitrage have affected the amount of gold in Germany?

The Germany imports goods from the arbitrage speculators in other Countries and pays with gold. Germany’s amount of gold will then start to fall.

iii.  Now consider the Bretton Woods system.

Suppose the official parity between the German mark and the USD was 4 DEM  (Deutschemark) = 1 USD.