Question 1:
Which of the following transactions would contribute to a US current account surplus and why (make sure that you justify, in each case, why would the transaction would/would not contribute to a current account surplus):
a. IBM barters a $100 million worth of computers to Jamaica in exchange for $100 million worth of hotel services on the island.
b. The US borrows $100 million long term from Europe to buy $100 million of European goods this year.
c. The US sells a $100 million worth of arms to Israel for $100 million bank deposits.
d. The US government makes a gift of $100 million to the government of Colombia, in the form of New York bank deposits, to pay for damages caused by US bombings in heroin plantations.
e. The European Central Bank buys $100 million in US-dollar bank deposits from a New York bank, paying by providing euro bank deposits to the New York bank.
Question 2:
Assume that in 1980, the price level for the US was 100, the price level for the UK was also 100, and in the foreign exchange market one pound sterling was equal to $1. In 2001, the US price level had risen to 310 and the UK price level had risen to 420.
a. According to PPP, what should be the $/pound sterling exchange rate in 2001?
b. If the actual $/pound sterling exchange rate is $1/pound sterling in 2001, is the pound sterling overvalued or undervalued relative to PPP?
Question 3:
A country now has a floating exchange rate. Its government would like to fix the exchange rate value of its currency to another currency. You have been hired as an advisor to the country's government. Suggest three major criteria for deciding what other country's currency to fix to. (You needn't mention any specific country, just analyze the important criteria). Why is each important?
Question 4:
"Countries whose currencies are linked to each other through fixed exchange rates usually pursue very different monetary and fiscal policies". Do you agree or disagree? Why?