Regular Homework 4
Economics 2000
Assigned Tuesday, November 20th, 2012
Due: Tuesday, November 27th, 2012
1. Calculate the sustainable deficit for Italy. Go the International Monetary Fund
World Economic Outlook Database. The WEO is a regular IMF publication:
http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx Go to By
Countries (country-level data) then Major advanced economies (G7) and select
Italy. Get Gross domestic product, current prices National currency; General
government net lending/borrowing Percent of GDP; General government
primary net lending/borrowing, Percent of GDP; and General government net
debt, Percent of GDP
for Start Year
through End Year
Download
your report .
a. Calculate the growth rate of current price GDP for every year between
2002-2011 (using the data from 2001-2011). What is the average growth
rate of GDP by value, gV?
GDPt  GDPt 1
So g V is defined as the average of gtV over 2002-2011 .
GDPt 1
We find gV = 2.46%
gtV 
b. The net debt to GDP ratio in 2011 is 100.4%. Using dy2011 =1 along with
the gV calculated in part a, calculate the sustainable level of the deficit for
2012.
gV
dyt 1 . Using gV = 2.46% , dy2011 =1so
Sustainable deficit is
V
1 g
.0246
1  .024 or 2.4%
1  .0246
c. Compare the sustainable deficit with the IMF projection of the deficit for
2012. The overall budget balance is reported in the WEO as General
government net lending. Is the Italian budget balance sustainable?
The IMF projects a general budget deficit of -2.35% which is just a bit
less than the sustainable level of 2.40%. This suggests the deficit is stable.
d. For each year from 2002 to 2011, calculate the net interest payments of the
government (as a % of GDP) as the difference between the general budget
deficit and the primary budget deficit. Calculate the average interest rate
i paid in each year as the ratio of net interest payments to net debt from
the previous year (i.e. dyt-1). Using the average of the interest rates for
2002-2011 as an estimate of the interest rate, i 20022011 , the gV calculated in
part a, and dy2011 =1 , calculate the sustainable primary balance for 2012.
General government balance is equal to the primary balance – net interest
payments so net interest payments is general deficits – primary deficits.
Call id = Net Interest Payments to GDP which is
i  Debtt 1
i
Debtt 1
i
1  gtV
idt  t
 t V
 t V dyt 1 it 
id t
GDPt
1  gt GDPt 1 1  gt
dyt 1
Average of it is i 20022011 is .0526 or 5.26%. The sustainable primary
i  gV
balance is
dyt 1 or 2.73%
1  gV
e. What if interest rates rise to i = .10. What primary balance would be
necessary to run a sustainable primary deficit?
.1  .0246
dyt 1 or approximately 7.36%
1.0246
2. The oldest central bank in the world is the Riksbank, the central bank of Sweden.
Its role is described at this website Riksbank. Describe the monetary policy of
Sweden along two dimensions: a. policy goals; and 2) operating instrument.
a.
What is the overall goal of monetary policy in Sweden? How does the
Riksbank define this goal in numerical terms?
b. What is the operating instrument? What is its current level?
3. Currency Misalignment. Calculate the over or undervaluation of some Asian
currencies. . Go to World Bank World Development Indicators and choose
China, Korea, and Thailand. From Economic Policy & Debt Purchasing power parity,
select PPP conversion factor, GDP (LCU per international $) , from Financial
Sector Exchange rates & prices select DEC alternative conversion factor (LCU per
US$) (a measure of the exchange rate) for 2005 and 2010.
a. Compare the exchange rate with the price of goods. Using this as a measure of the
competitiveness of the goods in this country, are these currencies under or overvalued in 2005 and 2010.
In this comparison, S > PPP in all cases, indicating the currencies are
undervalued.
2005
Country Name
China
Thailand
Korea, Rep.
2010
PPP
S
PPP
3.4475898
8.1943 3.965777
15.932102 40.22013 17.16652
788.92013
1024.12 824.5737
S
6.770269
31.68571
1156.061
b. Much of the goods that make up the market basket for calculating the PPP
conversion factor are not traded. Trade in industrial equipment constitutes a large
fraction of international trade. Consider the relative price of equipment and
machinery. Go to International Comparison Program. Go to the World Data Bank
at the World Bank. Choose International Comparison Program (2005). Again
select China, Korea, and Thailand. From Classification choose 1501 Machinery
and Equipment; from Series choose PPP (LCU per international $) for 2005 and
hit
. Shift Classification to Page.
Export to
. Compare the exchange rate with PPP for machines. Using
the relative prices of capital equipment, which currency is under- or over-valued?
Country Name
China
Thailand
Korea, Rep.
2005
PPP
S
8.7895654
8.1943
38.813405 40.22013
1152.3291
1024.12
Relative price of these goods is relatively more expensive. We see that China and
Korea are over-valued and Thailand is undervalued.
c. The data is not up to date. Calculate a PPP conversion factor for Equipment and
Maintenance for Korea and United States for 2010 by updating the price level. Go
to United Nations Main Aggregates database Basic Data Selection
http://unstats.un.org/unsd/snaama/introduction.asp. For China, Korea, Thailand
and the United States, get current value data (vMANU) from Value Added by
Economic Activity, at current prices - National currency
on Manufacturing (ISIC D) for
MANU
2005 and 2010. For the same countries and years, get volume data (q
) on
Manufacturing from Value Added by Economic Activity, at constant 2005 prices National currency. Use this data to calculate the price deflator for manufacturing
MANU
ptMANU  vtMANU q t
for t = 2005 and 2010 (Hint p2005=1). Calculate equipment
& machinery PPP2010 for each country j = China, Korea, and Thailand by
updating the PPP2005 with the change in manufacturing prices overMANU
MANU
p2010,
p2005,
j
j
time: PPP2010, j  PPP2005, j  MANU
.
MANU
p2010,USA p2005,USA
p 2010
2005
Country Name
China
Thailand
Korea, Rep.
p 2005
PPP
S
8.7895654
8.1943 0.960276
38.813405 40.22013
1.1709
1152.3291
1024.12 1.128125
2010
USA
PPP
1.052512
8.0193
1.052512 43.17919
1.052512 1235.113
S
6.770269
31.68571
1156.061
d. Compare PPP2010, j with the exchange rate. Which currencies were undervalued or
overvalued in 2010 using equipment PPP as a reference price.
In 2010, Asian currencies seem to be sharply overvalued when manufactured equipment
is used as a reference point.