International Economics, 7 Calculation Questions

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1. Consider the following data on August 1, 2016 (annual) interest rates US: 0.3% Brazil: 13.7% India: 6.5% Japan: - 0.18%, and August 1, 2016 US-dollar exchange rates (R$: Brazilian Real, BRL; RS Indian Rupee, INR R$3.2/$ RS 66.9/$ ¥102.3/$.

Use the Uncovered Interest Rate Parity relationship to derive the implied expected future (August 1, 2017) R$/$, RS/$, and ¥/$ exchange rates.

2. A Standard Keynesian model Consider the following model for the macroeconomy.

Consumption Function: C = a + b·Y
Import Function: IM = k + m·Y
Export Function: EX = k* + m*·Y*
where a, b, k, m, k*, and m* ≥ 0, and G, I, G*, I*, Y* are exogenous variables.

(a) Derive the goods-market equilibrium expression for GDP (Y) if the economy is closed (EX = IM = 0). What is the fiscal multiplier, ΔY/ ΔG?

(b) Derive the equilibrium equation for Y if the economy is open. What is the multiplier now?

(c) Derive the equilibrium equation for the trade balance (TB = EX - IM). What is the effect of fiscal policy on TB, ΔTB/ ΔG?

Now consider the following data (in constant, 2005 prices) for Brazil: billions of Real

Year GDP C EX IM

2004 2,105 1,259 239

2014 2,936 1,972 399 671

(d) Calculate the marginal propensities to consume (b) and import (m) over the 2004-2014 period.

Suppose there is a deterioration in Brazilian consumer confidence, which causes a drop in exogenous consumption, a, by 1% of (2014) GDP.

(e) Suppose Brazil is a closed economy. How would this drop in consumer confidence affect output? What fiscal policy (change in G) would prevent this output effect?

(f) Now suppose Brazil is open. How would the drop in consumer confidence affect output and the trade balance? What fiscal policy is needed now to neutralize the output effect?