Problem Set 6

1.	THE BASICS OF THE FOREIGN SECTOR GEOMETRY
	a.	Draw a basic foreign sector (NFI-NX) diagram to depict an initial situation in which a country has balanced trade. Be sure to label your axes and your curves
	b.	Why does NXLR slope down? Why does NFI slope up?
	c.	When the exchange rate deviates from its market-clearing level, what market pressures in (1) the current account and (2) the capital account push the exchange rate back to its equilibrium?

2.	CLINTON'S FISCAL POLICY
	a.	Use a foreign sector (NFI-NX) diagram to depict an initial situation in which the U.S. experiences a current account deficit (NX < 0) at its full-employment equilibrium.
	b.	Suppose the U.S. implements contractionary fiscal policy sufficient to eliminate its current account deficit in the long run. Depict in your diagram the new short-run equilibrium which results.

3.	THE GEOMETRY OF EXCHANGE RATE OVERSHOOTING
	a.	The 1980s was a period of expansionary fiscal policy for the U.S. Consider the following information about the U.S. economy:
		Year Real exchange rate (1973=100.0) Current account balance ($billion) 1980 84.9 +2.3 1985 132.5 -125.4 1987 90.9 -167.1
		Suppose that 1985 represented the consequences of the expansionary fiscal policy in the short run, while 1987 represented the long run. Draw a foreign-sector diagram for the U.S. which includes a short-run NX line (NX) and a long-run NX line (NXLR) and which shows the shift in NFI resulting from the expansionary fiscal policy. Use your diagram to label each of the numerical values in the table above.
	b.	Indicate in your diagram the portion of the dollar appreciation which illustrates exchange rate overshooting.

4.	THE J-CURVE IN THEORY: Suppose that, as of December, at an exchange rate of 3 marks per dollar, Germany's quantity demanded of dollars for current account purposes equals $6 billion and the U.S. quantity demanded of marks for net exports equals 18 billion marks.
	a.	Enter the U.S. net-export information (in billion dollars) for December in the table below:
		Part a Part b December March June September December X $6 $7       M           NX
	Now suppose that the value of the dollar falls on January 1st to a new level of 2 marks per dollar and that Germany's quantity demanded of dollars for net exports immediately rises to a permanent new level of $7 billion. The U.S. quantity demanded of marks adjusts as follows: March: 18 billion marks; June: 16 billion marks; September: 13 billion marks; December and thereafter: 9 billion marks.
	b.	Complete the rest of the table above, and use the information to draw a time path showing U.S. net exports over the time periods considered here.
	c.	Based on your computations, would a researcher recording current account information only for each December observe a J-curve? Explain briefly.

5.	THE J-CURVE IN PRACTICE: Consider the following long-run elasticity estimates for Germany:         German elasticity of demand for imports (eM): 0.88         Foreign elasticity of demand for German exports (eX): 1.12 Suppose that, when the mark depreciates, these elasticities rise one-fourth of the way to their final values during each six month interval over a two-year period (for example, during the first six months following a change in Germany's real exchange rate, the import and export elasticities average 0.22 and 0.28, respectively). Suppose that Germany's net exports initially equal zero and the mark suddenly depreciates.
	a.	In the table below, indicate whether Germany's net exports would be positive, zero, negative or uncertain during each six-month interval of the following two years.
	Depreciation date Month 6 Month 12 Month 18 Month 24 eM --- 0.22       eX --- 0.28       NX: +/-/0/?: 0
	b.	How did you determine your answers?

6.	THE GEOMETRY OF THE J-CURVE
	In the early 1980s, the U.S. Fed adopted contractionary monetary policy. Consider the following information about the U.S. economy:
	Year Real exchange rate (1973=100.0) Current account balance ($billion) 1979 83.2 -0.3 1981 101.5 +5.0
	Draw a foreign-sector diagram for the U.S. which includes a short-run NX line (NX) compatible with the information above, and then show the shift in NFI resulting from the contractionary monetary policy. Use your diagram to label each of the numerical values in the table above.

7.	FIXED EXCHANGE RATES WITH MOBILE ASSETS: Consider the Southeast Asian countries with fixed exchange rates and large current-account deficits in 1997 (for example, Thailand, South Korea, Indonesia and Malaysia).
	a.	Use an NFI-NX diagram to show the initial foreign-sector situation faced by these countries.
	b.	If the International Monetary Fund (IMF) had anticipated in advance the crises which ended up occurring in these countries in 1997, what policy recommendation(s) would it likely have made? Explain briefly, and illustrate the long-run   consequences in your diagram.

8.	FIXED VERSUS FLOATING: Decide whether the following is true or false, and explain briefly: With mobile assets, the short-run domestic impact of an increase in foreign interest rates tends to be expansionary with floating exchange rates and contractionary with fixed exchange rates.