ECO 6330: Exchange Rates and International Capital Markets Thomas Osang Problem Set 3: Answer Key Part I: 1. Question 2: In a closed economy, TB = NFIA = 0. Hence GNI = C + I + G. But this is exactly the deﬁnition of GNE. Hence, (1) GNE = GNI, Next, by deﬁnition, GNE + TB = GDP. With TB = 0 in a closed economy, it follows that (2) GNE = GDP. Eq. (1) and (2) combined imply that (3) GNI = GDP. In an open economy, CA = S - I (the so called current account identity). In a closed economy, CA = 0, and hence I = S. 1 2. Question 4: We are told that (all ﬁgures in million $) CA = -1000 FA-NR = 750 KA = 100 FIA = 700 TB = -800 NUT = 0 GDP = 9000 (a) Net export of assets = FA. Since CA + KA + FA = 0, FA = 1000-100 = 900. This means that the county occurred net foreign liabilities in the amount of 900, i.e. it borrowed 900 from the ROTW in 2007. (b) The oﬃcial settlement balance (OSB) is deﬁned at FA - FA-NR. Hence OSB = 900-750=150. (c) Note that NFIA = factor income from abroad (FIA) - income payment to foreign factors (IPFF). So, IPFF = FIA - NFIA. This means we need to ﬁnd NFIA. Note that NFIA = GNI GDP. This means we need to ﬁnd GNI. Note that GNI = GNDI since NUT=0. GNDI is deﬁned as GNDI = GNE + CA. This means we need to ﬁnd GNE. GNE is deﬁned as GNE = GDP-TB, that is 9000 - (-800) = 9800. This implies that GNDI=9800+(1000)=8800. Hence GNI=8800. Hence NFIA=8800-9000=-200. Hence IPFF=700-(-200)=900. (d) See answer to part c. (e) CA=-1000. KA=100. FA=900. Hence -1000+100+900=0. (f) See answer to part c. 2 3. Question 8: We are told that (all ﬁgures in million $) I = 400 EVK = 20 (i.e. evaluation eﬀects for domestic wealth) EXA = 160 IMA = 120 EVW = 1 (i.e. evaluation eﬀects for external wealth) (a) The change in domestic wealth is given as ∆ K = I + EVK . Hence ∆ K = 400 + 20 = 420. (b) The change in external wealth is given as ∆ W = -FA + EVW . Note that FA = EXA − IMA = 160 - 120 = 40. Hence ∆ W = -40 + 1 = -39. (c) The change in total wealth is given as ∆ (K+W) = I -FA + EVK + EVW . Hence ∆ (K+W) = 400 - 40 + 20 + 1 = 381. (d) Assume that KA=0. Then domestic savings are given as S = ∆ (K+W) - EVK - EVW . Hence S=381-20-1=360. (e) We see that Opulenza experienced a $ 420 million increase in its domestic wealth while losing $ 39 million in external wealth. $ 360 million of the increase in domestic wealth was ﬁnanced through domestic savings, plus wealth grew because of capital gains on the existing stock of wealth ($ 20 million). This leaves $ 40 million ﬁnanced from foreign sources. In other words, Opulenza pays for a good part of its growth in domestic wealth through borrowing from abroad - this is why its external wealth declined. It is also the reason for the CA deﬁcit. Opulenza enjoys relatively high spending (GNE > GDP) through running a CA deﬁcit and through borrowing from abroad. (f) A currency depreciation would not aﬀect the country’s domestic wealth, but will aﬀect its external and hence total wealth. In general, we expect that a depreciation will increase the trade balance and thus increase the current account. In this case, a currency 3 depreciation will lower the CA deﬁcit (say from -40 to -20) and thus lower the FA (from 40 to 20). This decline in the FA will improve the external wealth position since ∆ W will be -19 instead of -39. Since the external wealth position improves, the total wealth position will improve as well. 4