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Universitat Pompeu Fabra Introduction to Macroeconomics 2017-
María Gundín Problem set 5
SECTION A
Question 1
Consider the following article: Why use negative interest rates, by Andrew Walker (BBC World Service Economics correspondent, 15 February 2016).
1.1/ Explain the concept of zero lower bound and why it makes economic sense.
1.2/ Explain how is it possible that the real interest rate is below zero when the zero lower bound is effectively binding. Find a period in recent history when that has been the case. Support your assessment with a graph (hint: search at the web of the Federal Reserve Bank of St. Louis).
1.3/During the recession not only real interest rates have been negative but also we have experienced negative nominal interest rates. Find an argument in this article that explains why people would hold government bonds of certain countries with a negative nominal return. Explain it using what we have learnt in class in the Open Economy topic.
1.4/ Identify three reasons for why the central banks would set their reference interest rates below zero.
1.5/ Explain why, according to the article, banks are lending to each other at negative interest rates.
Question 2
Read the article that you will find in the following link and answer the questions. http://www.caixabankresearch.com/en/la-devaluacion-interna-clave- en-el-auge-de-las-exportaciones-f 2.1/ Explain what “internal devaluation” is.
2.2/ Compare the reduction in the real exchange rate in 2009- with the one observed in 1981-1984. Again use the function that defines the real exchange rate to explain the differences.
2.3/ Why does the article talk about devaluation instead of depreciation of the “peseta”?
2.4/ Explain how the Spanish economy attained a real exchange rate depreciation of 18.5% over the period 2009-2015? Relate that explanation to the function that defines the real exchange rate, ε = EP/P*.
2.5/ Why is internal devaluation so important to attain a more competitive Spanish economy nowadays that we have the Euro as our currency?
2.6/ Explain the relation between exports and real effective exchange rate.
SECTION B
Question 3 Assume that the interest rate for a one year maturity German government bond is 1%. The same maturity bond for the US government bond yields 5%. Consider as a reference for this problem the exchange rate between the euro and the dollar as of February 12 2018.
3.1/ Assume that the interest parity condition holds (that is investors consider that there are no differences in risk of the German bond and the US bond). Which are the expectations regarding the future exchange rate (in a year) between the euro and the dollar? Do financial investors expect an appreciation or depreciation of the euro respect to the dollar? By how much?
3.2/ Assume that that the real exchange rate of the euro respect to the dollar next year will be the same as the one this year, and the inflation rate in the euro area for next year will be zero. What will be the inflation rate in the US next year?
Question 4
Consider the following information on the trade balance of a country
Balance of Payments in millions of Euros Exports of goods and services Imports of goods and services 500, Investment income received 300, Investment income paid 200, Net transfers received Increase in foreign holdings of domestic assets 260, Increase in domestic holdings of foreign assets Statistical discrepancy 0
5.5 Compare the labor market of 5.3 with the one in 5.4. There is one which is dynamic and one which we may call “sclerotic”. Which is which? Explain why. What is the difference between the unemployment rates in these two markets? Explain.
