Contents
I strongly recommend that you do the end-of-chapter problems in your textbook. However, these are not required.
I recommend that you work these problems with a partner or a study group. (It need not be the same group every time.)
For theory questions, do not give short, purely descriptive answers! Make sure your answers are economic explanations.
Review the creation of vertical-bar charts in spreadsheets. (In Excel, these are called column charts.)
Video tutorial: https://www.gcflearnfree.org/excel2016/charts/1/
Verbal tutorial: https://subversion.american.edu/aisaac/notes/spreadsheet-intro.xhtml#bar-charts
Get current NIPA data for the US: gross domestic product (GDP), consumption (C), investment (I), government expenditures (G), and net exports (NX).
Make a bar chart from your data.
Transform C, I, G, and NX to percentages of GDP. Make a bar chart from your transformed data.
To produce a nice graph, we want a nice data format, and we need to normalize the data (to make it comparable across variable.)
Get the data; load it into Excel.
Select any cell in the data range, and then press ctrl+t to create a table from the data. Name it table01.
Excel cannot recognize the date data as dates. So we are going to create a column with a fully specified date varable. Start by creating the column. Add a table column to the right of the table Select a data cell in your table. Right click to get the context menu. Pick Insert » Table columns to the Right.
Because the date data specifies only a month and year, Excel does not recognize the date data as dates. We will add a day field to that it can do so. Use the DATEVALUE function to create dates as follow. In a cell in your new column, add the formula:
=DATEVALUE([date]&"-15")
(The choice of mid-month for the day was arbitrary.) Note how this formula uses structured references rather than explicit ranges.
Our use of DATEVALUE filled our new column with “date-time” values. We want these to display in a familiar date format. Select the data, right click to get a context menu, pick Format Cells, and pick a date format to your taste.
Rename the new column as zdate.
Next we want to normalize our data. Here is how to do that for the spot rate. Create a new column, names nspot, and then enter the following formula:;
=[spot]/INDEX([spot],1)
As a side note, this formula is not database compatible, because it indexes by a particular row number rather than by a row identifier that is part of the table (in the case, the date). We do this for spreadsheet simplicity, but if you wish, you can change the INDEX expression to get:
=[spot]/INDEX([spot],MATCH("1990-01",[date],0))
Create a time-series plot of your normalized data against the date, changing the y-axis to a ratio scale. (Use lines wihout markers.)
Go to the BEA's interactive tables to get the data for this exercise. Report the US current account for the past decade in current dollars and as a percentage of nominal GDP. As a general tendency, has the current account getting “worse” or “better”? What about most recently? Justify your assessment carefully.
What is the significance of a country's international investment position (IIP)? What is the relationship between the IIP and the current account (CA)? Go to the Bureau of Economic Analysis and retrieve a decade of time series data for the IIP and CA. Plot them together in a single graph. Discuss the relationship between the two. Comment on any historical trends.
Explain why our DD curve slopes upward in (Y, E)-space. Start your explanantion with a depreciation of the domestic currency (i.e., an increase in E). You may refer to figures in your text if you wish.
Hint: When you are working on the DD curve: treat E as exogenous. So do not ask why E changes, just ask what happens if E changes.
Explain why our AA curve slopes downward in (Y, E)-space. Start your explanantion with an increase in the real income Y. You may refer to figures in your text if you wish.
Hint: When you are working on the AA curve: treat Y as exogenous. So do not ask why Y changes, just ask what happens if Y changes.
Using your AA-DD model of a floating exchange rate, discuss the effects of a permanent increase in M. (This is a change in the level of the money stock; you do not need to not worry about inflation expectations.) What change if any is there from our asset-markets-only results?
Using your AA-DD model of a fixed exchange rate, explain the sense in which fiscal policy is more effective than monetary policy, given high capital mobility and a fixed exchange rate. How does your explanation shed light on the “impossible trinity”?
Data-based HW: Long-Run Purchasing Power Parity parts 1-6.
Without worrying about data quality, retrieve about a decade of monthly money, price, and exchange rate data for Zimbabwe from the International Financial Statistics. Explain (step by step!) how you get this data into your software application. Create a beautiful and informative graph, containing all three series. Comment on the relationships you see in the data, relating them to our discussions in class. Things to think about include the following.
Explain the difference between absolute purchasing power parity, relative purchasing power parity, and expected purchasing power parity. Summarize the basic intuition behind relative purchasing power parity, and then summarize the reasons we might expect deviations from relative purchasing power parity even in the long run.
Consider the following data from the IFS:
SE: 1948-2007
=============
Initial q: 39.05
Item: Gross Percent
US Inflation: 8.61 760.89
Home Inflation: 16.76 1575.76
Predicted Depreciation: 1.95 94.66
Actual Depreciation: 1.78 78.17
Final q: 35.74
Real depreciation: -8.47%
The data collected are for E, P, and P*. What country is this data for? What is meant by "predicted depreciation"? What is illustrated by this data?
If you did the above exercises carefully, you have learned a lot about using gretl. Remember to list familiarity with gretl on your resume!
Unfortunately forward rate data are bit hard to find free online. But at least for the moment, UBC at the website http://fx.sauder.ubc.ca/CAD/forward.html offers a summary of forward rates at various maturities. Use these data for the following exercises. (You should submit your spreadsheet and the document containing your write up.)
Enter the spot and forward exchange rates into a single column of your spreadsheet. (The spot rate is 0 months forward.)
Examples:
On 2011-11-24 I found reported the following exchange rates (spot and forward):
| Months Fwd | Rate |
|---|---|
| 0 | 0.9539 |
| 1 | 0.9533 |
| 2 | 0.9527 |
| 3 | 0.9522 |
| 6 | 0.9511 |
| 9 | 0.9505 |
| 12 | 0.9494 |
| 24 | 0.9457 |
The data are not always so complete. (Missing values were typical during the global financial crisis.) Naturally, your numbers will depend on the date you access the webpage. Be sure to document your date of access and the date specified for the data.
Use your spot and forward rate numbers to compute the rest of the table you see at this website. That is, add the appropriate formulae (from the website) to your spreadsheet in order to compute the forward premium points on CAD (also called the swap rate) and the implied foreign interest rate differential. Note that you are not supposed to find the formulae in your book or notes: you are to use what you have learned to figure these out by reading this website. (The premium is just a scaled arithmetic difference, and FIRD is defined on the UBC page.) In your homework document (not your spreadsheet), please explain the formulae that you use.
Produce a graph similar to the UBC graph of forward premium points but with one difference: plot your computed values of the implied foreign interest rate differential instead of the forward premium points.
Based on your graph and data, how would you describe the market's expectations about how the USD-CAD exchange rate will behave over time? Explain carefully.
Note
The website formula already produces a percent value, so do not use your spreadsheet to do this a second time (e.g., by setting the cell formatting).
Note
Computations in the UBC table sometimes appear slightly off at short horizons. I inquired about this and was told it is due to rounding error in the exchange rate reporting. And actually, you can see that the data are rounded by looking carefullly at the accompanying graph, which is apparently based on the raw data.
Note
Do not fill your graphs with fancy “fluff” (like 3-D images). (If effective presentation of data is likely to be part of your work, you may want to read the work of Edward Tufte.)
Note
If you are going to speak of an “exchange rate depreciation”, make sure it is clear which exchange rate (CAD-USD or USD-CAD) you mean. It is generally better to speak, e.g., of a USD appreciation or depreciation.
Your US company is expecting a payment from an EU firm of 1M EUR in 3 months. How can you hedge your exposure to exchange rate risk in the forward market? Consider the following scenario. The EUR-USD spot rate is 1.48. Your bank offers you a EUR-USD 3-month forward rate of 1.50. Your EUR-USD (3 month) expected future spot rate is 1.48. If you contract today what do you pay your bank on the settlement date? Does it matter if your expectations prove correct or incorrect?
Your US company is expecting a payment from a CN firm of 1M CNY in 3 months, but since CNY are nondeliverable you will receive instead the US value of 1M CNY on that date. The Chinese forward market for CNY is restrictive and unattractive, but there is an active offshore market in nondeliverable forward contracts. How can you hedge your exposure to exchange rate risk in the nondeliverable forward market? Consider the following scenario. The USD-CNY spot rate is 6.82. Your bank offers you a USD-CNY 3-month NDF rate of 6.75. Your USD-CNY (3 month) expected future spot rate is 6.82. If you contract today what if anything do you pay your bank on the settlement date? Does it matter if your expectations prove correct or incorrect? (Be very specific about the details, so that it is clear that you understand the difference between an NDF contract and a forward contract.) You may find the follwing helpful: http://www.bis.org/publ/cgfs22fedny5.pdf
Consider our very first short-run model of exchange rate determination, which is simply based on the uncovered interest parity relation. Suppose we are in an initial equilibrium at E1, where it happens that the expected exchange rate E e equals the current exchange rate. This equilibrium is disturbed by a rise in the expected exchange rate. (I.e., a depreciation of the expected future value of the domestic currency---in this case, the USD.) Ceteris paribus, precisely how does the equilibrium spot rate change in this model, and why?
Analyze our first exchange-rate “overshooting” model, which uses the uncovered interest parity relation to explain exchange rates in the short run and the the neutrality of money to explain exchange rates in the long run. Suppose we are in an initial equilibrium at E1, where it happens that the expected exchange rate equals the current exchange rate. Next, this equilibrium is disturbed by a one-time permanent rise in nominal money stock. In the short run, precisely how does the equilibrium spot rate change in this model, and why? In the long run, precisely how does the equilibrium spot rate change in this model, and why? Describe the transition from the short run to the long run. What is the relevance of this distinction between the short-run and long-run effects to our understanding of the influence of monetary policy on the behavior of exchange rates?
Some homework assignments require the use of gretl, the Gnu Regression, Econometrics and Time-series Library. This is a free (GPL), cross-platform, open-source regression package. Almost every gretl command introduced in these homeworks is discussed in the excellent gretl manual. Be sure to <em>read about each command</em> before you use it.
Make sure you are using a computer that has gretl installed. (If you are using your own computer, you can download gretl for free; the installation is simple.) Double-click the gretl icon. You will see the main gretl window appear.
There is a special data format for gretl. (But see the discussion of CSV.) Save the your gretl datafile to your working directory. (E.g., g:\thisclass\mygretldata.gdt.) If you are working in a lab computer, be sure to save it to your network drive, not to the c: drive!
Now you will open your datafile. You can do this three ways (try all!).
Note
notice that you can type the same commands at the console or in a program file. If you type them in a program file, you have access to them when you come back to gretl at a later date. Therefore you will complete this homework by adding commands to your command-script file.
Now open your working copy of the data and examine the data. If I have given you a gretl data set, you can click once on the variable name. This highlights the variable name and some additional information about the series. Pay attention to this information!
You can also double click any variable name. A window opens displaying the values of the series.
The comma-separated value (CSV) format is an almost universal data exchange format. To import CSV data into gretl, make sure it has the right format. Your file should have variable names (a name has no spaces!) on the first line and a rectangular data matrix on the remaining lines. That is, each row after the first represents an observation (one period), and each column represents a variable (all periods, sequentially).
You can use the menus: File/OpenData/Import/CSV. For your scripts, use the import command.
Countries have surprisingly varied policies toward providing free access to macroeconomic data produced with tax payer dollars. For example, detailed Canadian time series data are sold by Statistics Canada, while South Africa makes a substantial amount of data freely available. Suppose I need a time series for the CAD-USD exchange rate, and I do not have funds to buy it from StatCan. How could I use the data at http://www.resbank.co.za/economics/histdownload/histdownload.htm to produce this? Be sure to describe the following:
Note
Be careful with your notation: the CAD-USD exchange rate is the number of USD it takes to buy a CAD. The first currency in the pair (the CAD in this case) is the base currency; the second currency in the pair (the USD in this case) is the quote currency.
Go to the table of currency cross rates at http://marketwatch.nytimes.com/custom/nyt-com/html-currencies.asp and make the following checks:
a. for the USD versus the GBP, EUR, and JPY check for consistency of the direct and indirect (i.e., reverse) quote.
b. for the GBP, EUR, and JPY check for consistency of the reported cross rates with the synthetic cross rate you can construct by going through the dollar.
In class we showed that covered interest parity should always hold when capital mobility is high. We usually work with the approximation
R - R* = F / E - 1;
the exact expression is
F/ E = (1+ R)/(1+ R*).
Suppose the three-month interest rate on XYZ deposits is 3.1%/year. The three-month interest rate on USD deposits is 1.5%/year. Suppose the present spot exchange rate is USD 0.9 per unit of XYZ. Compute the three-month XYZ-USD forward rate, and explain your computation in detail.
Explain why our DD curve slopes upward in (Y, E)-space. Start your explanantion with a depreciation of the domestic currency (i.e., an increase in E). You may refer to figures in your text if you wish.
Hint: When you are working on the DD curve: treat E as exogenous. So do not ask why E changes, just ask what happens if E changes.
Explain why our AA curve slopes downward in (Y, E)-space. Start your explanantion with an increase in the real income Y. You may refer to figures in your text if you wish.
Hint: When you are working on the AA curve: treat Y as exogenous. So do not ask why Y changes, just ask what happens if Y changes.
Using your AA-DD model of a floating exchange rate, discuss possible policy responses to a temporary fall in domestic demand. Give a detailed account of the pros and cons of responding with monetary or fiscal policy.
Using your AA-DD model of a floating exchange rate, discuss possible policy responses to a temporary fall in domestic demand. Give a detailed account of the pros and cons of responding with monetary or fiscal policy.
Using your AA-DD model of a fixed exchange rate, discuss the following from the perspective of China's macroeconomic performance. (Note that the AA-DD model assumes perfect capital mobility. Analyze these questions under that assumption. You can then add qualifications if you wish.)
Is a current account deficit necessarily “bad” for a developing country?
Why do interest rate differentials persist across countries?
What is a "nominal anchor" and how does it benefit a developing country?
What is the role of the central bank in a fixed exchange rate regime and what are the possibilities for sterilized intervention?
What are the options for the Chinese central bank in their current situation?
What are the important features of multilateral exchange rate pegs?
What are the arguments for and against fixed/floating exchange rate regimes?
What determines an optimal currency area and do countries benefit from dollarization?
Familiarize yourself with the data available at http://www.ecb.int/stats/exchange/eurofxref/html/index.en.html
Get data for any country that interests you. Collect spot rate and price data for your country for the most recent year possible and going back as far as feasible, up to three decades. (Make sure your exchange rate and price data end in the same year and that your initial price index has the same base year as your current price index.) Use your exchange rate (against the dollar) data to calculate the gross depreciation over the entire period: e.g., S(2004)/S(1973). (Note that this is “gross” in that it is not turned into a percentage change by subtracting 1.) Let us call your price indices P(1973,b) and P(2000,b), where b is the common base year. Use these to compute the gross inflation over the period: e.g., P(2004,b)/P(1973,b). If your gross inflation calculation differs from your gross depreciation calculation by an order of magnitude or more, you have probably made a mistake in your data collection.
Turn in a brief write-up. Report your data, computations, and conclusions. Include a precise statement of where you got your data. (Precise enough to ensure replicability. If you used the Web, include the date of access.)
You may use any data source: just be sure to document your data source precisely. I encourage you to use one of the best known and most widely used sources of international macro data: the IMF's International Financial Statistics. Your library has the IFS online.
Note
some countries will not have data for three decades or will be obviously far from equilibrium at the beginning of the period. Feel free to accommodate this; just provide explanations.
Note
If you have only P(1973,b1) and P(2000,b2) where b1 and b2 are two different base years, you will have to get another piece of data, P(b2,b1), so you can calculate P(2000,b1)=P(2000,b2) x P(b2,b1). Don't forget your price indices will be expressed as percents: e.g., a reported value of 270 means P=2.7. %move next note to here
From Measuring Worth, download the following data.
Organize your data in a spreadsheet. Let the column headers be:
date spot cpius rpiuk
where 'spot' is your GBP-USD exchange rate, 'cpius' is your CPI for the US, and 'rpiuk' is the retail price index for the UK. Make sure your data is in columns underneath these headings.
Next compute a US/UK real exchange rate (from 1800 onward). Produce a line graph of the behavior of this real exchange rate over time. Give your graph an appropriate title and make sure the axes are appropriately labeled. Add a note explaining precisely how you calculated the real exchange rate and what you learn about long-run PPP from your graph. While you may of course bring in additional considerations, be sure your discussion directly addresses topics raised in class.
Go to the Bureau of Economic Analysis (BEA) website (http://www.bea.gov/) and find the Balance of Payments data. What is the latest quarterly reported value for the U.S. current account? (Use the news release, but report this as an annual rate.) What does this say about the production and spending of the US? Explain.
In this same report, find the data for the components of the current account (the balances on goods, services, income, and unilateral transfers). State each balance in dollars (quarterly rate) and as a percentage of the total. Which of these balances accounts for most of the current account deficit?
Go to the daily financial summary at http://www.rbc.com/economics/market/pdf/fmd.pdf and use the annualized 3 month rates to compute a quarterly interest differential. Compute the forward premium on US dollars, using the last table on the same page. (Comment: be careful with the table, which first reports exchange rates for the USD and then for the CAD. Note the use of both direct and reverse quotes in the same table!) What relationship should hold between your two computed values? Does it?
For this problem, read chapter 6 of the http://www.gpoaccess.gov/eop/index.html 2006 Economic Report of the President. How would a household run a capital account surplus, in the sense of this chapter? (Note the chapter title uses an old terminology: they mean capital and financial account.) How does the ERP explain the US capital and financial account surplus? What remedies does it propose for this "external imbalance"? Does this explanation make sense within the AA-DD framework?