PROBLEM SET IV

show your calculation make sure to make a good length answer

1.

a)      Assume that there is new information released today that implies a permanent increase in the domestic output level by 10%, starting in T periods. Explain intuitively in the context of the flexible price, one good, PPP model, with i=i*+DE/E, why this shock leads to a currency appreciation today.

b)      Explain intuitively why the exchange rate overshoots in the Dornbusch overshooting model when there is a permanent 10% increase in the money supply.

c)      Explain why the forward discount puzzle may be the result of a time-varying risk premium. Specifically, what are the properties of the risk premium to make this work?

2.

a)      Is the Bretton Woods system collapse an example of a “first generation” balance of payments crisis?  What about the 1997 East Asian crisis? Explain.

b)      Why can rumors lead to a currency crisis when a country has a lot of short-term debt relative to international reserves, even when all the fundamentals of the economy are fine?

c)      Explain why during emerging market crises a devaluation often has significant contractionary effects (even though in our models it has always been expansionary).

d)     What is meant by “moral hazard” in the context of third generation currency crisis models?

3.

a)      Explain why in the Maastricht Treaty restrictions were imposed on government debt and deficits for a country to enter the Euro zone (stage 3).

b)      Explain how the 1992/1993 EMS crisis can be thought of as a crisis of self-fulfilling beliefs.

c)      Explain why one of the costs of a currency union is the difficulty in having relative prices adjust and how did this make things worse when the capital flow reversal during the Euro crisis lead to significant austerity. 

1.

a)      Assume that there is new information released today that implies a permanent increase in the domestic output level by 10%, starting in T periods. Explain intuitively in the context of the flexible price, one good, PPP model, with i=i*+DE/E, why this shock leads to a currency appreciation today.

b)      Explain intuitively why the exchange rate overshoots in the Dornbusch overshooting model when there is a permanent 10% increase in the money supply.

c)      Explain why the forward discount puzzle may be the result of a time-varying risk premium. Specifically, what are the properties of the risk premium to make this work?

2.

a)      Is the Bretton Woods system collapse an example of a “first generation” balance of payments crisis?  What about the 1997 East Asian crisis? Explain.

b)      Why can rumors lead to a currency crisis when a country has a lot of short-term debt relative to international reserves, even when all the fundamentals of the economy are fine?

c)      Explain why during emerging market crises a devaluation often has significant contractionary effects (even though in our models it has always been expansionary).

d)     What is meant by “moral hazard” in the context of third generation currency crisis models?

3.

a)      Explain why in the Maastricht Treaty restrictions were imposed on government debt and deficits for a country to enter the Euro zone (stage 3).

b)      Explain how the 1992/1993 EMS crisis can be thought of as a crisis of self-fulfilling beliefs.

c)      Explain why one of the costs of a currency union is the difficulty in having relative prices adjust and how did this make things worse when the capital flow reversal during the Euro crisis lead to significant austerity. 

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due time 5 hours sharply from now