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May 201 9
Page 1 of 6
M ARKING SCHEME
EXAMINATION PAPER: ACADEMIC SESSION 20 18 /201 ...
May 201 9
Page 1 of 6
M ARKING SCHEME
EXAMINATION PAPER: ACADEMIC SESSION 20 18 /201 9
Campus Greenwich Maritime /International Partners
Department International Business and Economics
Course Code ECON11 03
Course Title Macroeconomics 1
Duration 2 HOURS
Date May 2019
Course co -ordinator: Ozlem Onaran
INSTRUCTIONS TO CANDIDATES
Answer 3 questions only .
All questions carry equal marks .
This is a CLOSED book examination.
THIS PAPER MUST NOT BE REMOVED
FROM THE EXAMINATION ROOM
May 201 9
Page 2 of 6
Compare and critically evaluate the position of the neoclassical and Keynesian
economics regarding the proposals that the government budget should be balanced each
year (i.e. no budget deficits).
• New classicals would be in favor of this because they believe that stabilization
policy is actually destabilizing. A balanced budget amendment would tie the
hands of government in using fiscal policy to stabilize output.
• Keynesians would be strongly against this for exactly the same reasons
monetarists would be for it. T hey argue for the use of stabilization policy and
would be against anything that constrains the ability of government to use fiscal
policy to stabilize output.
A full mark requires full discussion and elaboration around the key words above.
May 201 9
Page 3 of 6
Discuss the relative advantages and disadvantages of flexible vs. fixed exchange rates
(including the differences between fixed exchange rate regimes based on soft vs. hard
pegs). Support your arguments with examples.
• Advantages of a flexible exchange rate system
• 1. freeing domestic policy instruments from a balance of payments constraint
• In a fixed exchange rate system, there are potential conflicts between domestic and
external goals. For example, an expansionary monetary policy, which might be
desirable from a domestic standpoint, could result in an unacceptable balance of
payments deficit. In a flexible exchange rate system, the exchange rate will move to
clear the foreign exchange market and remove this type of c onflict.
• however, this presumes that the policymaker is indifferent about the level of the
exchange rate, which might not always be the case. If the exchange rate is viewed as a
policy goal, then conflicts between domestic and external goals may exist in the flexib le
exchange rate case as well.
• 2. insulating the domestic economy from foreign shocks to aggregate demand.
• Advocates of a fixed exchange rate system argue that such a system provides a more
stable environment for world trade and investment.
• Proponents of fixed exchange rates are also concerned that speculation on currency
values might cause exchange rates to fluctuate excessively in a flexible exchange rate
• Some advocates of a fixed exchange rate system believe the discipline that the balance
of payments constraint places on policymakers will have a beneficial anti -inflationary
May 201 9
Page 4 of 6
In the wake of the financial crises that afflicted many developing countries during the
1990s, many participants in international financial marke ts at times came to fear that the
exchange rates underpinning the currency boards maintained by Hong Kong and
Argentina might be devalued. Explain what effects you would expect such fears to
have on domestic interest rates and on real economic activity in those two countries.
Use also graphical illustration to support your discussion.
• According to UIP, the expectation of a future devaluation would cause the BP curve to
• at previous r massive capital outflow
• CB sells FX buys domestic currency
• LM shifts left
• the domestic interest rate increases.
• The equilibrium level of real GDP would contract.
• + graphical illustration
Ee↑, BP ↑ (R*mpc out of R
- the relative size of the consumption differential out of wage vs. profit income
+ partial effect on investment:
Investment depends on both demand and profitability
the sensitivity of investment to profits (partial)
+ effect on net exports
the sensitivity of net exports to unit labor costs
Total effect on demand is ambiguous
if total effect is -: wage -led dem and
if total effect is +: profit -led demand
• If growth regime is „not profit- led“:
– room for egalitarian redistribution policies, without harming the growth potential
– pro -capital incomes policy neither necessary nor sufficient to achieve higher
employme nt and growth
– decline in domestic demand can have detrimental effects on long term growth potential
– Prisoners dilemma:
– beggar -thy -neighbor policies via wage moderation
– the limits of strategies of international competitiveness based on wage competition in a
highly integrated global economy
– wage coordination
– To stabilize income distribution & demand
– Productivity -oriented wage setting & convergence
May 201 9
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Discuss the effects of domestic and international financial liberalization on the economy
in terms of financial fragility and risk factors. In particular discuss the mechanisms,
which generate the cycles of boom and bust after international financial liberalization.
• Common points in the recent crises in the developing countries (late 1990s and 2000s)
– Fiscal house in order
– Government’s withdrawal from the real economy & deregulation in domestic &
inter national financial markets
• high interest rate or financial returns
• + initially cr edibly fixed or predetermined FX rate (nominal anchor against inflation –
crawling peg) or initially low expected exchange rate depreciation
• thus wide arbitrage to attract short term and volatile capital inflow
– International capital flows
• Destabilizing fina ncial sector behaviour
– Locals borrow abroad to lend domestically/buy domestic assets
– Risky financial system balance sheet
• short on FX, long on local assets
• Maturity mismatch
– High risk and high return projects
– High indebtedness
• capital inflow boosts growth
– boom euphoric expectations
• Macroeconomic paradox:
– individual risks shifting to aggregate
• Public deficits and moral hazards at most secondary
• Boom -Bust cycle:
• Currency appreciation
• → current account deficit increases
• Expected depreciation rate increases
• Higher i nterest rate is needed to attract more capital
• illiquidity and insolvency risk
– Threat of a systemic crisis
• Bankruptcies →
– Bank distress and loan defaults
• Credit crunch
• credib ility of the economy decreases
• Downturn i nevitable
• Capital outflow: bust
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