Exchange Rates and Macroeconomic Policies

The Formula for Calculating Exchange Rates

Consider the following formula Ets$=$t+1  s$=$t = i$t  i$t;where s$=$t is the logarithm of the nominal exchange rate in period t deÖned as pounds per dollar; i$ tis the short term interest rate in the UK and i$tis theshort term interest rate in the US.

1) The formula above captures which theory?

a) Purchasing Power Parity

b) The International Trilemma

c) Uncovered Interest Rate Parity

d) The Theory of Comparative Advantage Consider augmenting the equation as follows:Ets$=$t+1  s$=$t

i$t  i$t= t

2) What is t?

a) The Fed Funds rate

b) The equity premium

c) The currency risk premium

d) None of the above

3) If t is positive, a risk neutral investor (investor who doesnít care about risk) will

a) Borrow in the UK and invest in the US

b) Borrow in the US and invest in the UK

c) Insu¢cient information to answer the question

4) If is negative, a risk averse investor (investor who cares about risk) will

a) Borrow in the UK and invest in the US

b) Borrow in the US and invest in the 

c) Insu¢cient information to answer the question

5) If the exchange rate is pegged and the peg is credible (the UK adopts a currency board vis-a-vi the US) the following is true

a) t = 0

b) t > 0

c) t < 0

d) All of the above

PART C: Short Essay Questions (20 points) Each essay is worth 10 points.

Be brief and precise in answering the following questions. (Word limit: no more than 250 words per question, where if you choose to use an equation in your answer it wonít count towards your word limit.)

1) Debt Sustainability

Discuss what are the key variables that one needs to consider when assessing the debt sustainability of a country and why?

2) Forward guidance

Describe what forward guidance is? Why was forward guidance introduced? How was it supposed to a§ect the economy? Was it e§ective and why yes or why not?

D) Long Essay (40 points) (Page limit: the maximum length is 3 pages ó1.5 spaced; font size: 12. Supporting graphs and tables can be placed separately in an Appendix and will not count towards the page limit.)

Evaluate the short- and long-run impact of the COVID-19 shock on the UK economy.

Answer each of the sub-parts using the theories and concepts introduced in class and use additional data sources (see suggestions below).

Cite your sources clearly. Heavily citing newspaper articles or other sources will be penalized since I expect you to perform the analysis independently and to rely on the theories taught in class.

1) How did the COVID - 19 shock a§ect the components of aggregate demand and supply in the UK? Use data to support your answer.

2) What are the key macroeconomic challenges in the short and long run in the UK due to COVID ñ 19?

3) What was the response of the Bank of England? What are the challenges to monetary policy?

4) What was the response of the Öscal authority? What are the challenges to Öscal policy?

5) How did the Önancial sector facilitate/hinder the transmission of both monetary and Öscal policy?

6) What is your overall forecast for the recovery of the UK economy post COVID - 19