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Econ 161 - International Macroeconomics

Instructor: Jesus Sandoval-Hernandez

University of California Merced


Fall 2013

Sample Final
Instructions: Answer all questions. To receive any credit you MUST show your work.
1. For each of the following situations, use the IS-LM-FX model to illustrate the effects of the
shock. For each case, state the effect of the shock (increase, decrease, no change, or ambiguous)
on the following variables: Y, i, E, C, I, TB. Assume the government responds by using monetary
policy to stabilize output.
a. A tax cut.
b. Foreign interest increases.
c. Investors expect an appreciation of the home currency.
d. The money supply decreases.
2. For each of the following scenarios, assume the economy experiences an exogenous decrease
in investment demand. For each case, illustrate the IS-LM-FX diagram and state the effect of the
shock (increase, decrease, no change, or ambiguous) on the following variables: Y, i, E, C, I, TB.
Here, we assume the policy makers objective is to keep output fixed at its initial value.

a. Monetary policy response under a floating exchange rate regime.


b. Fiscal policy response under a floating exchange rate regime.
c. Monetary policy response under a fixed exchange rate regime.
d. Fiscal policy response under a fixed exchange rate regime.
3. The Bulgarian lev is currently pegged to the euro. Using the IS/LM diagrams for home
(Bulgarian lev) and foreign (Eurozone) illustrate how each of the following scenarios affects the
Bulgarian lev. Assume that this fixed exchange rate regime involves noncooperative adjustments
to interest rates and that the Eurozone is the center country.
a. Bulgaria increases government spending to finance social welfare programs.
b. The Eurozone countries decrease the money supply.
c. Investors expect a depreciation in the Bulgarian lev relative to the euro.
4. Consider a noncenter home country that is part of a fixed exchange rate regime. The home
country currently has output higher than its desired level. Concerned about inflationary

pressures, central bankers want to contract the money supply. Using the IS/LM diagrams for a
home and a foreign country, show how each of the following would affect home and foreign
output. In which cases are the monetary policy objectives inconsistent with the home country
remaining in the fixed exchange rate regime?
a. The foreign country is a center country. Compare a cooperative versus a noncooperative
adjustment in interest rates.
b. The foreign country is a noncenter country. Compare a cooperative versus a noncooperative
adjustment in exchange rates.
5. Suppose a country has $2,000 million in moneysupply and $1,200 million in reserves.
a. Illustrate the central bank balance sheet diagram. Calculate the backing ratio.
b. Because of a recent banking crisis, the central bank extends $800 billion in credit to deal with
liquidity problems in the banking system. Illustrate this situation a new central bank balance
sheet diagram. Is the country still able to maintain a fixed exchange rate? Explain how you
know.
Suppose that rather than the previous scenario described, the central bank extends $800 billion in
credit to prevent bank insolvency. Illustrate this situation on your graph. Is Patria able to
maintain a fixed exchange rate? Explain how you know.

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