ECM136 2019/20 Exam Paper – Questions 1/4 University of Reading Department of Economics ECM136 Advanced International  Macroeconomics and Finance 2019/20 Exam Paper – Questions   Answer TWO questions__________________________________ Definitions (must be dense but precise/complete)   (10 marks each for a total of 50 marks)   the volume (or “policymakers”) quotation system (with respect to the nominal exchange rate)   the real effective exchange rate (REER) index   the Marshall-Lerner(-Harberger) condition   static (or naive) expectations   the “fundamentals” in the asset price approach to the exchange rate     Global Forex Market Turnover, Transaction Shares and Definitions   Figure 1 presents the global forex market turnover

ECM136 2019/20 Exam Paper – Questions 1/4

University of Reading

Department of Economics

ECM136 Advanced International 

Macroeconomics and Finance 2019/20

Exam Paper – Questions

Answer TWO questions__________________________________

1. Definitions (must be dense but precise/complete)

(10 marks each for a total of 50 marks)

1. 1. the volume (or “policymakers”) quotation system (with respect to the nominal exchange rate)

1. 2. the real effective exchange rate (REER) index

1. 3. the Marshall-Lerner(-Harberger) condition

1. 4. static (or naive) expectations

1. 5. the “fundamentals” in the asset price approach to the exchange rate

2. Global Forex Market Turnover, Transaction Shares and

Definitions

1. Figure 1 presents the global forex market turnover. Describe its evolution in terms of absolute value (right scale) and relative to US

GDP (left scale).              (10 marks)

Figure 1: Daily Global Foreign Exchange Market Turnover, Average for April. Source: BIS (website).

2. Figure 2 illustrates the trends in the relative importance of the forex market segments that channel each of the types of forex transactions, or forex financial instruments. Discuss these trends and define the depicted forex financial instruments.            (40 marks)

Figure 2: Share of Traded Instruments in the Global Foreign Exchange Market, % of total. Source: BIS (website).

3. The Monetary Approach to the Balance of Payments

The monetary approach to the balance of payments (BoP) was developed in the 1960s, in part within the research department of the IMF under the intellectual leadership of Jacques Polak and in the context of the Bretton Woods system of fixed exchange rates.

1. Enumerate its main assumptions.         (20 marks)

2. Analyse and interpret its equilibrium condition, which we wrote in the lectures as:

where ??_? is (the log of) international reserves,  is (the log of) the nominal exchange rate,  is (the log of) the Foreign price level, ?_? is (the log of) Home output,  is the Foreign interest rate, ?_? is (the log of) domestic credit, 0 < ? < 1 is the fraction of international reserves in the total assets of the central bank, ? > 0is the income

elasticity of money demand and ? > 0 is the interest-rate semi-

elasticity of money demand.           (30 marks)

4. Meese and Rogoff's (1983) Exchange Rate Disconnect Puzzle

1. Using the reported results in Table 1, describe the work of Meese and Rogoff (1983) and define the exchange rate disconnect puzzle.

               (25 marks)

2. Summarise how the literature on exchange rate modelling and forecasting developed in response to Meese and Rogoff (1983). In particular, enumerate what is known at present about the predictability or not of exchange rates (you should be able to list at least half a dozen conclusions – without the need to cite precise references).             (25 marks)

Table 1 – Root Mean Squared Error (RMSE) of the Exchange Rate Models. Source: Meese and Rogoff (1983).

(End of Question Paper)

5. Intertemporal Approach to the Current Account

The intertemporal approach to the current account, as illustrated in the simple two-period model of a small open economy, involves the following optimisation problem of the representative agent:

subject to the present-value intertemporal budget constraint:

where c_i is consumption and y_i is the endowment of a perishable good, with the subscript i = 1, 2 referring to the time period; U_l denotes lifetime utility, u(c₁) and u(c₂) being the instantaneous utilities in each of the two periods; and the constants 0 < ? < 1 and r are, respectively, the subjective discount factor and the real interest rate.

1. Derive and interpret the first-order conditions for this general

optimisation problem.            (15 marks)

2. Analyse the role of international borrowing and lending by focusing on the special case when _{? ?} ¹ and y₁ < y₂.      (35 marks)