INTERNATIONAL
ECONOMICS—FINAL EXAM
(3-4 pm, July 23, 2004)
Instructor: Professor Kenichi Ohno
l This is a closed book exam. Use your pen and brain only.
l PLEASE WRITE CLEARLY. Poor handwriting will be ignored, resulting in lost points.
l ANSWER ALL QUESTIONS. Use only TWO official answer sheets. Use only FRONT side of each answer sheet. Allocate space carefully.
l Clear and concise answers are preferred. Long answers do not guarantee high points.
l After the exam, model answers will be distributed. Graded answer sheets will be returned to the students a few days later and overall results will be posted in the web.
Answer in any order; each question carries 20 points
Q1. Describe the price-species
flow mechanism. Is it a valid model of the classical gold standard
(1879-1914)?
Q2. What caused the first oil shock (1973-74)? Present two alternative views.
Q3. Explain the first generation models and the second generation models of currency crisis.
Q4. Evaluate the IMF’s
policy advice at the time of the Asian financial crisis (1997-98).
Q5. The
Model answers
(Other answers are often possible)
Q1. The PSF mechanism is a model of automatic
balance-of-payments adjustment through gold flows and price change. If the
current account (CA) is in deficit, gold flows out of the country, causing
monetary contraction and price deflation. This improves competitiveness and CA.
The reverse occurs when CA is in surplus. However, the PSF mechanism ignores
capital mobility. Under the classical gold standard with integrated goods and
financial markets, external adjustment was quickly achieved via private capital
flows, without a forced slow change in money or price levels across countries.
Q2. The supply shock view argues that global
stagflation was caused by the OPEC’s aggressive oil price increase, shifting
the aggregate supply curve upward which raised prices and reduced output. This
was combined with wage rigidity, which increased unemployment further. Floating exchange rates were beneficial as a shock
absorber. By contrast, the global monetarist view says that the OPEC action was
the result, not the cause, of worldwide excess liquidity, which in turn was
caused by currency interventions of major countries at the time of the collapse
of the Bretton Woods fixed exchange rate system. According to this view, the
lack of an effective global nominal anchor was the cause of both general
floating and commodity inflation in the early 1970s.
Q3. The first generation models state that a policy
inconsistent with a fixed exchange rate (continued budget deficit and monetary
expansion) inevitably leads to a currency crisis. The exact timing of the
attack depends on the shadow exchange rate, a hypothetical exchange rate which
would prevail after the attack. The second generation models argue that attacks
are possible even without any apparent policy failure. Policy nonlinearity
leads to multiple equilibria where both attack and non-attack solutions are
possible. Crisis dynamics is driven by private traders who exhibit such
irrationalities as herding, self-fulfilling attacks, information cascade,
sunspot equilibria, etc.
Q4. Ex ante, IMF often encouraged LDCs to
open up financial sectors prematurely. Ex post, IMF applied current
account policies to the capital account crisis--a mismatch between the disease
and the cure. In particular, the following IMF conditionalities are now considered
inappropriate: (i) macroeconomic austerity at the time of collapsing private
demand; (ii) high interest rates to stop the currency fall; and (iii)
structural reform measures adopted in the middle of crisis, including bank
closures in Indonesia. Some argue that the Asian crisis worsened unnecessarily
due to these measures. In 2003, IMF issued an evaluation report which largely
admits to such criticisms.
Q5. The US Congress and industrial lobbies criticize
major trading partners whenever the