Fordham University
Crises Adjustment & Poverty
Economics 5450
Fall 2015
Online midterm Questions M-1 to M3A v3A
Midterm Essays M-1 to M-3A (do part C or D): See Nov. 9th calendar for due dates. Use Metzler, TNT or Elasticities
diagrams from these spreadsheets where possible. See video for custom copy/paste instructions. Revised lecture notes for
M-3 part B. Answer using the typed + online diagrams approach used for homework, of draw in diagrams and/or
equations by hand and take a picture, or use electronic pictures and equations—remind me to post word versions of
handouts and spreadsheets with diagrams (Figure 1, etc.) Please note each essay is turned in separately and has its own
due date on blackboard & the calendar. Use this word file template adding your answer in a different single spaced type
face. Keep answers brief, please clearly label and refer to points in diagrams. Check the course calendar & Blackboard
for due dates and possible revisions or corrections. Send me an email if links to readings do not work.
M-1 Managing Aid surges and sudden stops a) Coping with capital inflows: use the curved TNT diagram such as
Figure 1 to show how private capital or Aid inflows always lead to a real exchange rate appreciation. Briefly relate this to
idea of “absorbing” Aid inflows. B) Countries with a flexible exchange rates have some control over how this
appreciation takes place. Using the nominal exchange rate e (pesos, or Rand per $) and price level eq. from S&L Chapt 21
to explain the potential inflationary impact of capital inflows. What can countries that have (don’t have) their own
currency do to mitigate inflationary impact of capital inflows? C) pick a country that has and has not graduated. Link the
policy options just discussed to the three measures of graduation discussed in that handout. What can or did your
countries do to cope surges of capital outflows, if any? D) Coping with capital outflows: the 2013 “taper tantrums” are
aptly named as they involved largely exogenous outflows of capital from many emerging or frontier (EorF) market
economies. Use Figure 1 to show capital outflows (or at least a return to Autarchy or A) What can policy makers due to
cushion the shock of capital outflows if they control e and if they do not? Why is internal devaluation so much more
difficult that external devaluation? Discuss the effects internal vs. external devaluation have on wages: why might this be
important (politically) during a crisis? E) Use the TNT or the market for dollars diagram to show how Chile’s copper
stabilization fund smooths consumption and investment. Simulate a rise/fall in copper prices as a shift in the supply of
dollars curve, or as a shift in the PPF that mainly affects traded goods. F) The third arrow of Abe Economics is reforms to
encourage investment and productivity growth (Germany’s Hartz reforms are an example).Use the TNT model to argue
that countries that wish to temper the impacts of Aid inflows on inflation and RER should increase productivity in _____
goods while countries seeking to avoid deflation associated with capital outflows should focus on increasing productivity
in _________goods. Explain this intuitively and using the TNT diagram if possible. (G) How does a real estate boom
amplify the boom bust cycle created by capital inflows (or commodity price increases). How can governments counter
this trend? Should governments fight asset bubbles (pro and con)? Why might they regret these efforts (or the lack
thereof) later on? Ben Bernanke and Alan Greenspan and
many other economists do not think the Central Banks
Nontraded
Figure 1
should shoot down “asset bubbles” (others do, Rajan
and Krugman?). Discuss the pros and cons of using
monetary policy to “lean against” asset bubbles
governments may use other policies to counter
bubbles, such as…] G) S&L Chapt 21 argue that in real
life a country would never produce at G. Why not? Are they
wrong or is Greece a special case? (hint: Argentina 1998-2001)
H) interactive Economist housing price chart1 or the IMF’s
Global Housing site to compare booms across countries which
countries had the largest booms? Are they still suffering or did
they recover nicely.
QN
CN = CT
Goods
●
●
B
●
A
●
G
C●
-q = PT/PNT
PT = ep*
Traded Goods
1
QT
Economist, Global house prices, Clicks & Mortar www.economist.com/blogs/freeexchange/2011/03/global_house_prices
M-2 aka The Senegal Question or should WAEMU devalue as if its 1993? A) Suppose you wanted to use the
Salter Swan-TNT model to measure exchange rate misalignment among WAEMU countries see Figure 8.1
from Chapter 8 of A) Why is overvaluation of the GDP deflator the appropriate measure of exchange rate
misalignment for the CFA Franc countries? What components of the RER are missing from Table 8.1? When
might these missing components be relevant? B) Which countries have overvalued RERs, which do not? What
could countries do on their own to fix this problem? (hint: 2 of three Arrows left). Why are both of these fixes
problematic and difficult and costly? (hint: Greece). C) In 1994 the CFA Franc zone countries devalued
(unexpectedly) by 100%. This Chapter 1 discusses what happened. Pick one or two countries (or the region)
and look what happened to inflation and growth from 1994 to 2008 (more or less)? Why do we worry about
output and inflation after a large devaluation? How can inflation wipe out the effects of devaluation? (see the
USDA data) Was 1994 a good or bad development for the countries you have data on. The data you need to
answer this question should be available online Saturday November 7th or November 9th latest. E) Why is it so
hard to for CFA France countries to graduate? Have any African countries graduated? EC: which according to
UNICEF protect social spending (“adjustment with a human face”). Make a case for devaluation or aid using
the above arguments. Another name for the SS-TNT model is the “dependent economy” model, why is this
relevant in this context? F) Required for PhD students: How does the DLR CGE model improve on the
assumptions of the Salter-Swan model? Why has this model become the benchmark for analysis of financial
crisis worldwide since 2007? It is a descendant of the 123 model, why call this the 123 model (2 reasons). Why
is this model more important for countries that have fixed as opposed to flexible exchange rates? How can we
use this model to make the case for aid vs. exchange rate flexibility? For a very nice discussion of the DLR or
123 model as an upgraded Salter-Swan model, see Chapter 6an and the Agenor text Chapter 9 last 10 pages.
References
Chinn, Menzie D (2006) "A primer on real effective exchange rates: determinants, overvaluation, trade flows
and competitive devaluation." Open economies review 17.1 (2006): 115-143.
Devarajan, Shantayanan, Delfin S. Go, Jeffrey D. Lewis, Sherman Robinson, and Pekka Sinko (1997) "Simple
general equilibrium modeling." Applied methods for trade policy analysis: A handbook, Chapter 6 (above is
WR version, here is DESA copy).
Devarajan, Shantayanan (1999) Estimates of Real Exchange Rate Misalignment with a simple General
Equilibrium Model” chapter 8 in Hinkle, L. E., and P. J. Montiel eds (1999) Exchange rate misalignment:
Concepts and measurement for developing countries. Oxford University Press, see Chapter 8, the entire book is
in the CD Reader.
Gulde, Anne Marie, and Charalambos G. Tsangarides (2008) The CFA franc zone: common currency,
uncommon challenges. International Monetary Fund, see Chapter 1
http://www.imf.org/external/pubs/nft/books/2008/cfazone/chap1.pdf
Ortiz, Isabel, Matthew Cummins, and Kalaivani Karunanethy. "Fiscal Space for Social Protection: Options to
Expand Social Investments in 187 Countries." Available at SSRN 2603728 (2015).
M-3A: Is financial autarky best? Though most countries are well aware of various speed and “sudden stop”
hazards of Aid and international capital flows, most remain choose integration over autarchy in global capital
markets. A) Why do donors almost make foreign aid contingent on IMF membership and supervision? Why is
the IMF concerned that developing countries “absorb” aid? Use a Metzler diagram so show what happens if
countries do not absorb aid (rather move from on A to another A for autarchy). Why is China, with all the
reserves any country could want seeking to make its currency more convertible so it can be in the SDR?
B) In “Managing the World Economy” Ken Rogoff (2002) argues “the IMF has not been a cheerleader for burgeoning
current-account imbalances, especially when they start to look unsustainable… But at the same time, if we begin to think
ahead, it becomes obvious that the real challenge is not to reduce current-account imbalances but to find ways to sustain
bigger ones, albeit properly directed.” For a small country, A) Masters students: use the Metzler diagram (see updated
Modern Approaches lecture notes and/or Sachs Chapter 6 or F&R chapter) to show consumption smoothing, augmenting
and tilting. With smoothing recall the domestic savings curve shifts back and forth, for tilting, we are a poor high interest
rate country with autarchy luckily to be living in a low interest rate world, while for augmenting everyone wants to invest
in our country, but our savings are low… PhD students: use Frenkel and Razin Chapter 5 diagrams to make the same
arguments as above using the C1 & C2 intertemporal CA model. If possible, explain your answer using both Figures
and relevant equations from Chapter 5, focus on the key parameters that drive each type of borrowing/lending.
Do part C or D of this question
C) Smoothing natural volatility: theory an open capital account is particularly advantageous for commodity exporters
(CEs). Why? (recall smoothing, augmenting, tilting). Why in reality are few of these benefits realized? (too few CE
graduates?) How have some CEs realized the benefits of open capital markets? (hint: Felipe Larraine). Why can’t other
countries replicate this model (or can they)? (see Frenkel on the Dutch Disease and a list of CE graduates ).
D) Large economy & good neighbor? Suppose a large country (China) creates a market for land and cuts safety nect
services leading to a large domestic savings boom. Use the Metzler diagram show the effect of this savings boom on
domestic and international interest rates with closed and & open capital markets. Focusing on its CA, what does China
have (see Figure 9 below, “Chimerica”)? Start with a two panel diagram like Figure 8 below or Figure 6-11 in S&L with
a large country (China) on the left and the rest of the world on the right (start with domestic S=I where A is for Autarchy).
Show what happens to world interest rates of China has a closed capital account (holding domestic S=I). Compare this to
open capital market case (the rest of the world or U.S. for example). Should China’s trading partners prefer open or
closed Chinese capital market? Briefly, why did China accumulate $3 Trillion in reserves (part E explains how not why)?
E) PhD students only: show how sterilization works using the Polak model from Chapter 9 of Agenor or the MABP
handout. What is do we need add to this model or is missing in this model? Does sterilization2 allow countries to escape
the “impossible trilemma”? If not, how does China do the impossible? Harder: discuss how an open capital account
might benefit China when and if its present domestic investment boom ends?
Extra Credit F) EC Masters students: Sometimes be careful, or you might get what you wish for: Rajan (2010)
Chapter 10 and Krugman (2011) were fairly pessimistic about ending China’s CA imbalances via policy initiatives. But
as Sachs, 2015 points out, there were overly pessimistic, the Balassa-Samuelson is working: Chinese wages are rising and
its RER appreciating, much as the Yen did after the Plaza Accord. Why might this be good for CA imbalances, but bad
for China and the World (and especially for developing countries)? Sachs’s article is nice, but the Figures are a bit
strange, see if you can find the source and label them properly using our nominal Fx Template.
2
See Barry Ickes notes forex1.pptx on google to see how sterilization works, or for verbal and nice pictures see Chuck Moulton’s
lecture notes, (the graphics may not make sense unless you have seen the movie…. Still not mission impossible… )
For M-2 and M-3 Metzler diagrams get this file http://class.povertylectures.com/Econ5450_MetzlerDiagramsFall2014.xlsx
Figure 8: Large Cty imbalances start with both ctys with trade
China
Large Country 1
Large country 2 or ROW*
world
interest
rate
S(r)
S'(r)
S(r)
r
r
A
r0
I(r)
I(r)
S0 = I0
I,S
S0 = I0
I,S
Bottom line: China has bigger boom, lower interest rates, nothing happens
happens to the United States because all new savings stay in China
*ROW stands for "rest of world" or the U.S. (nations outside China).
A is for “Autarchy” not a norm, just a starting point, shift one curve on for large country 1 then rebalance with the
other diagram, in the “world” CA deficits and surpluses must add to zero. In real life, there is a discrepancy, but it is
getting smaller and it changes in sign, the October 2014 WEO.