ECOS3029: Assignment 1. Marked out of 70. Answer all parts of all questions. Please
provide supporting details of your calculations.
1) [9 marks] National Accounts Exercise. Suppose that the value of national account
aggregates in China for a year are:
Exports of goods and services: ¥250;
Imports of goods and services: ¥160;
Private consumption expenditure: ¥300;
Government consumption expenditure: ¥100;
Government tax revenues: ¥150;
Investment: ¥200;
Income received from foreign investments: ¥50;
Income paid to foreign investors: ¥50.
a) [3 marks] If the above list of transactions is complete, what is the Trade
Balance for China as a % of Chinese Gross National Income (GNI), correct to
at least 1 decimal place?
b) [3 marks] What is the Current Account Balance for China as a % of Chinese
GNI, correct to at least 1 decimal place?
c) [3 marks] What is the value of total savings in the economy?
2） [25 marks] Intertemporal Model. Assume that a small open economy runs for 2
periods and has production, investment, and a representative consumer with:
• Lifetime utility function:
= ln(1) + ln(2)
• Production function:
=
0.7where the initial capital stock is 1 = 200
• Capital Stock in Period 2:
2 = 1 + 1
, where 1 is period‐1 investment
• Access to international credit markets at an interest rate
=0.15.
• (1+)=1.
• Initial Net International Investment Position: 1 = 0.
a. [3 marks] Write down the maximization problem for the
representative consumer
b. [8 marks] Solve for the optimal investment level 1 for the economy
in period 1.
c. [2 marks] What is the optimal investment level 2 for the economy in
period 2?
d. [9 marks] Solve for optimal consumption levels for the economy in
both periods.
e. [3 marks] What is the current account balance of the economy in
Period 1? What are total savings in the economy in Period 1?
3) [18 marks] Sudden Stops and Current Account Reversals. Consider the data for a
country in the table below. All parts to this question are worth 3 marks each.
a. Do you think it is optimal for this country to be running current account deficits
(briefly explain your answer)?
b. What features of this data suggest that there is an increased likelihood of this
country experiencing a “sudden stop” of capital inflows and a current account
reversal (briefly explain your answer)?
c. What features of this data suggest a low likelihood of a “sudden stop” of
capital inflows and a current account reversal (briefly explain your answer)?
d. If the country were to experience a current account reversal, do any features
of the data suggest that the economic growth impact would be less substantial
than normally occurs during such a reversal (briefly explain your answer)?
e. If the country were to experience a current account reversal, do any features
of the data suggest that the economic growth impact would be more
substantial than normally occurs during such a reversal (briefly explain your
answer)?
f. Is there any other data you would like to observe to be able to better assess
the likelihood of a sudden stop of capital inflows and a current account
reversal (briefly explain your answer)?
Current
Account
Balance
Investment
Productivity
Index
Imports
Exports
Exchange Rate
(% of
GDP)
(% of GDP)
(2009=100)
(% of
GDP)
(% of
GDP)
(local currency
units per USD)
2009
‐16.2
37.2
100.0
122
107
2.44
2010
‐14.0
34.7
108.6
127
118
2.44
2011
‐15.6
37.5
113.3
164
149
2.44
2012
‐13.4
34.9
116.1
146
137
2.44
2013
‐12.0
35.0
123.1
159
149
2.44
2014
‐10.5
33.2
129.7
169
163
2.44
2015
‐9.0
34.6
138.1
170
165
2.44
2016
‐10.9
35.6
149.4
190
185
2.44
2017
‐13.1
39.5
162.4
209
202
2.44
2018
‐11.1
42.1
171.5
203
198
2.44
2019
‐8.9
45.8
175.8
187
185
2.44
4) [19 marks] Exchange Rates. Report answers correct to at least 3 decimal places.
a. [2 marks] If the spot exchange rate /=0.15, then what is the spot
exchange rate /?
b. [2 marks] If the spot exchange rate /=1.05, and the spot exchange
rate / = 1.25, what is the spot exchange rate /?
c. [2 marks] If the spot exchange rate / = 4.75, and the spot exchange
rate /=0.75, what is the spot exchange rate /?
d. [4 marks] Assume that you are an investor with 1,000 USD in an account and
observe the following spot exchange rates: / =0.75,
/=0.8583, / =1.1452. Assuming that there are no
transaction costs, what foreign exchange trading/investment strategy would
you adopt?
e. [2 marks] Assume that (i) the one‐year forward exchange rate
/ =1.0505 (ii) the current spot exchange rate / =1.0859;
and (iii) the one‐year interest rate for EUR is ∗ =9.23%. What must one‐year
CHF interest rates be for Covered Interest Parity (CIP) to hold?
f. [3 marks] The current value of the spot exchange rate /=1.05. If the
Canadian (CAD) inflation rate for the coming year will be 4% while the
Australian inflation rate will be 2%, what value of the exchange rate
/ 1 year from now would maintain Relative PPP?
g. [3 marks] Assume that consumers consume only 2 items: Rent; Food. In
Germany, rent for 1 year is EUR 15,000 and food for 1 year is EUR 7,500. In
Australia, rent for 1 year is AUD 20,000 and food for 1 year is AUD 7,500. If
the spot exchange rate is / =1.616, what is the real exchange rate
between Australia and Germany (treat Australia as the domestic country)?
At what value of the nominal exchange rate / would Absolute PPP
hold?
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