Expert answer:Interest Rate parity
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e333au17.hw2.pdf
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THE UNIVERSITY OF ILLINOIS AT CHICAGO
ECON 333: INTERNATIONAL ECONOMICS
AUTUMN 2017
Prof. George Karras
Your name:
Homework 2
1. [2 points] Consider the following data on September 2017 (annual, short-term) interest rates
US: 1.3%
Mexico: 7.4%
Russia: 8.8%
Denmark: – 0.3%,
and September 2017 US-dollar exchange rates (MXN: Mexican New Peso, RUB: Russian Ruble,
DKK: Danish Krone)
MXN 17.83/$
RUB 58.73/$
DKK 6.25/$.
Use the Uncovered Interest Rate Parity relationship to derive the implied expected future
(September 2018) MXN/$, RUB/$, and DKK/$ exchange rates.
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2. A Standard Keynesian model [8 points] 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*, m* are positive parameters; 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?
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(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, 2010 prices) for Brazil (OECD, Main Economic
Indicators, National Income Accounts):
Brazilian Real, billions
Year
GDP
C
EX
IM
2000
785
496
76
2016
1,147
763
156
146
(d) Calculate the marginal propensities to consume (b) and import (m) over the 2000-2016 period.
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Suppose there is a deterioration in Brazilian consumer confidence, which causes a drop in exogenous
consumption, a, by 1% of (2016) 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?
…
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