Problem 1. Look at the economist website at:
https://www.economist.com/markets/indicators
Using the tables from the latest issue of the Economist, please answer the following questions. Please clearly state your assumptions that you need. Please clearly show, in detail, the calculations and steps you use to arrive at your answers. Please do not use any other sources for the data required to answer these questions. Based on Britain (£) and Australia ($).
a. For all practical purposes, are real interest rates about equal (real interest rate is nominal interest rate, adjusted for inflation) in these two countries?
b. Compared to last year, has the Australian dollar appreciated or depreciated against the pound and by how much? (Please provide your complete reasoning and computations). Is that what you would expect based on your answer to part a? Explain your reasoning.
c. Identify any two other pieces of information from the tables that might, in theory at least, help to explain appreciation or depreciation of the Australian dollar in general. Now determine whether the actual data from the tables are consistent with your answer to part b (about the appreciation or depreciation of the Australian dollar).
Problem 2. Consider a small country, MadhatterLand trades goods and assets with the rest of the world consisting of perfect capital markets.
a. Suppose MadHatterLand has fixed exchange rate. The governor of the Central Bank, Ms. March hare, attempts to increase aggregate domestic demand through an unsterilized, open market expansion of money supply.
i. What will happen to the overall BOP and why?
ii. What will happen to the forex holdings of the Bank and why?
b. Now suppose MadhatterLand has a fully floating exchange rate (i.e. Bank never intervenes in the forex market to affect exchange rates). Again, Ms. March Hare chooses to expand domestic demand through expansion in money supply.
i. What will happen to the overall BOP and why?
ii. What will happen to the exchange rate and why?
Problem 3. Consider a Mexican firm that knits sweaters for sale to a U.S. department store. The firm incurs total costs of 16 pesos/sweater, and sells the sweater to the department store for $5 per sweater. The exchange rate is 4 pesos/$.
a. What is the firm markup per sweater as a percentage of revenues?
b. If the peso is devalued 20%, what is the new value of the peso?
c. If the firm keeps dollar prices constant and peso costs constant, what is the markup per sweater as a percentage of revenue after the devaluation?
d. If the firm decides to keep the gross margin per sweater constant (at 20%), would sales expand or decline? Why? What would the new dollar price be after devaluation?