Questions for Term Paper in Open Economy
Macroeconomics
University of Oslo, Department of Economics, September
2001
1. Discuss what determines the degree of capital mobility between currencies.
2. It is sometimes claimed that capital mobility in today’s world is close
to perfect. Comment brießy on this proposition.
3. Another claim is that capital mobility has made it more difficult to
keep exchange rates Þxed. Explain why this may be true.
4. ”Currency boards” are sometimes promoted as institutions that can
keep exchange rates Þxed in spite of high capital mobility. Explain
what a currency board is and how it deviates from an ordinary Þxed
rate system.
5. Enclosed is a model of a small open economy. It is assumed that all
goods are traded internationally and the exchange rate is Þxed. The
central bank uses the interest rate, not foreign exchange interventions,
to keep the exchange rate at its target level. Factor prices are ßexible,
which means that output is determined from the supply side. The
government budget is balanced. Explain brießy how the model can be
used to determine the time paths of the foreign debt and the current
account deÞcit and derive the relevant stability condition.
6. Suppose there is a positive shift in the consumption function. Discuss
on the basis of the model what this means for the time paths of the
foreign debt and the current account deÞcit. How do the effects depend
on the degree of capital mobility?
7. Suppose one day the central bank buys a certain amount of foreign
currency. How is the path of the current account affected? What does
capital mobility mean for the result this time?
8. The government of the economy gets an unexpected revenue from
abroad. Its value is equal to Z units of goods per year, and this
income stream will last τ years. Two proposals have been made:
1
(a) Reduce taxes by the amount of the extra revenue for as long as
the revenue lasts.
(b) Reduce taxes forever by an amount equal to the annuity equivalent of the extra revenue
(1 − e−ρ∗ τ )Z.
In other words, only the permanent income that the extra revenue
gives rise to is handed out as tax reductions.
Compare the time paths of the currenct account and the interest rate
in the two cases.
9. Discuss the adequacy of the given model for discussing the question
raised in 8 in real life situations.
Deadline: 15 October 2001. The papers will be marked by Asbjørn
Rødseth, who will also go through the answers in a lecture planned for week
45 (date and time later). Answers can be given in Norwegian or English.
2
Model
Equations:
Ẇ∗ = ρ∗ W∗ + C − Y
C = C(Yp , Wp , ρ∗ + r, ρ∗ ), 0 < CY < 1, CW > 0, Cρ∗ < 0
Yp = Y − ρ∗ W∗
r = i − i∗ − Ė/E
Wp = −W∗ − Wg
Fg
= −f(r, −Wg − W∗ ) − W∗ , 0 < fW < 1 < 1, fr0 < 0
P∗
Variables:
W∗ = foreign debt
C = consumption
Y = output
Yp = privat disposable income
ρ∗ = foreign real interest rate
r = risk premium
i = nominal interest rate
i∗ = foreign interest rate
Wp = private net assets
Wg = government net assets
E = exchange rate
Fg = foreign exchange reserve
P∗ = foreign price level
(1)
(2)
(3)
(4)
(5)
(6)
Initial conditions:
M0 + B0 + EFp0
E(0)P∗ (0)
−M0 − B0 + EFg0
=
E(0)P∗ (0)
F∗0
=
P∗ (0)
Wp =
Wg
W∗
Determination:
Endogenous: W∗ , Wp , C, Yp , r, i
Exogenous: ρ∗ , i∗ , P∗ , E, Y, Fg
Predetermined: M0 , B0 , Fp0 , Fg0 , F∗0
Wg is determined by initial condition and Ẇg = 0.
3
(7)