Seminar Questions for Open Economy
Macroeconomics Fall 2001
Asbjørn Rødseth
September 10, 2001
First seminar: The monetary approach to exchange rate determination
1. Write down the simple monetary model of exchange rate determination.
and explain how the exchange rate is determined.
2. How does a permanent increase in the foreign interest rate affect the
exchange rate and the domestic intererst rate?
3. Suppose there is an unexpected increase in the foreign interest rate
today. The increase is expected to last for two years. Sketch in two
graphs the effects on the time paths of the exchange rate and the domestic interest rate.
4. Because of news of an imminent boom abroad, the foreign interest rate
is expected to increase one year from now and then to remain high for
two years before it returns to its old level. Sketch in two graphs the
effects on the time paths of the exchange rate and the domestic interest
rate.
5. Compare the effects of a permanent increase in the foreign interest rate
on the exchange rate and on the domestic interest rate in the monetary
model and a standard portfolio model. What are the differences in
assumptions that account for the differences in results? Compare also
to the Dornbusch model, if you have got this far in your reading.
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6. Explain how a government deÞcit may affect the exchange rate in the
monetary approach. What can the government do to prevent such
effects? Is there any reason why a current account deÞcit should affect
the exchange rate or the interest rate in the monetary approach?
Second seminar: Traded and non-traded goods
1. In the model of Section 7.1 of OEM, discuss the effects of a wage cut
on employment in the two industries and on the trade balance.
2. Suppose that there is real wage rigidity and that the exchange rate is
Þxed. What is then the effect of a cut in the real wage on employment
in the two industries and on the trade balance? Compare the results
here and in question 1.
3.
a Suppose the savings rate σ in the model of Section 7.1 depends
positively on the domestic rate of interest. What is then the effect
on employment in the two industries of an increase in the interest
rate?
b Retain the assumption about the savings rate from a. Suppose
now that the exchange rate is ßoating and that the central bank
keeps the domestic interest rate constant. How would you modify
the model of Section 7.1 to cover this case? What is now the
effect on employment in the two industries of an increase in the
domestic interest rate?
4. Suppose the oil price increases. Discuss the impact this will have on employment and the trade balance in an oil-exporting and an oil-importing
country.
5. In the model of Section 7.1 a devaluation and a wage cut has the same
real effect. Can you think of reasons why in a more general model a
devaluation and a wage cut may have different effects?
6. Make a list of reasons why a devaluation may be contractionary. Try
to make the list as exhaustive as possible (not limited to models with
n− and t−goods).
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Third seminar: Wage dynamics
Question 1.
We are looking at a small open economy with two industries, one producing traded and one producing non-traded goods. The country is a
price taker in the world market for traded goods. Capital is used only
by the traded goods industry. Wages are decided in bargaining between
employers and unions. Assume the following model:
(1) N = N(ω t , Gn , τ , Kt ), Nω < 0, NGn > 0, Nτ < 0, NK > 0
ω̇ t
(2)
= −γ(ω t − g(N )), γ > 0, g 0 > 0
ωt
K̇t
(3)
= I(ρt (ω t ) − ρ∗ )
Kt
where N is actual employment, ω t is the real wage in terms of traded
goods, Gn is government consumption of non-traded goods, τ is the tax
rate, Kt is the capital stock in the traded goods industry, ρt (ω t ) is the
rate of return on capital in the same industry, and ρ∗ is the real rate of
return in international Þnancial markets. g(N) is the equilibrium real
wage that results from the wage bargaining. The endogenous variables
are N, ω t and Kt , the exogenous are Gn , τ and ρ∗ . There is short-run
nominal wage rigidity and the exchange rate is Þxed.
(a) Explain brießy the background for the investment equation (3). What
properties will you assume for the functions I and ρt ?
(b) What is the stationary equilibrium of the model? What are the effects
of an increase in τ on the stationary equilibrium?
(c) Draw a phase diagram for the model and explain brießy why it looks the
way it does. Is the stationary equilibrium stable?
(d) A country has a large current account surplus because investments are
unusally low. Suppose you are a foreign exchange speculator. On the
basis of the present model, what would you expect to be most likely, a
devaluation or a revaluation?
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(e) In an open economy wage increases may in some cases lead to higher, not
lower, employment. Explain why this may happen. Suppose Nω > 0.
Does this make the stationary equilibrium unstable? Does it change
the effect of τ on employment in the stationary state?
Question 2
Suppose we are in the extremely open economy of chapter 5 in
OEM. There is perfect capital mobility and the exchange rate is
Þxed. Employment is determined by
(4)
N = Np (ω, K) + Ng,
Npω < 0
where ω is the real wage, Ng is government employment and K is the
capital stock, which now is an exogenous constant. Real wage growth
is determined either by a standard Phillips-curve:
(5)
ω̇
= γ(N − N̄) γ > 0
ω
or by the alternative wage equation
(6)
ω̇
= −γ(ω − g(N )) γ > 0, g 0 > 0
ω
(a) Explain brießy the reasoning behind the alternative wage equation and
why it differs from the standard Phillips-curve.
(b) Suppose there is an exogenous increase in Ng . What effect does this
have on the time paths of ω and N in the two cases?
(c) Explain why the current account will be balanced in the long-run in
either case
(d) Suppose the exchange rate is ßoating instead of Þxed. What differences
does this make for the effect of Ng on the time paths of ω and N?
Fourth seminar: Foreign debt dynamics, etc
Question A
Consider the following model, taken from Chapter 6 in OEM (symbol deÞnitions there):
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EF∗
EF∗
EP∗
)
− G, −
− Wg , i, i∗ ) + G + X(
, Y, Y∗(1)
P
P
P
Ṗ = P γ(Y − Ȳ ),
γ>0
(2)
EP∗
P
Ḟ∗ = i∗ F∗ − X(
, Y, Y∗ ).
(3)
E
P
Y
= C(Y − i∗
Endogenous variable are Y , P and F∗ , exogenous are E, G, i, i∗ and Y∗ .
The initial values of P and F∗ are given by past history. The intitial
value of Wg is given by past history once the exchange rate has been
determined.
1. Sign the (partial) derivatives of the behavioural functions of the
model. Explain brießy how the X-function is arrived at and discuss brießy the sign of XR (R = EP∗ /P ).
2. Discuss the effect of gradual changes in F∗ and P on the short-run
equilibrium for Y .
3. What is meant by a stationary equilibrium in the model? What
is required for the stationary equilibrium to be stable?
4. What are the effects on the time paths of P , F∗ and Y of a negative
shift in the consumption function (”increased savings”)?
5. Discuss whether a devaluation can be a useful response increased
savings.
Question B
1. Compare the effects of supply and demand shocks on output
in an economy with a Þxed exchange rate and in one which
practices price level targeting.
2. What relevance does the answer to 1 have for the question of
whether or not a country should join a monetary union?
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